The stock market has been on a wild march higher this year — driven by the White House's shifting trade policy, geopolitical concerns, and conflicting economic data. The barrage of headlines — both positive and negative — is creating an intimidating backdrop. The good news? The way to value stocks stays the same, no matter the market. It's a critical part of the investment process. Even though stocks move fast these days, and it can be hard to keep up, investors need to remember the old adage: Price is what you pay, value is what you get. If you want to be sure you aren't paying too high a price for a given stock, you had better know how to value it. Only then can you determine whether a stock is overvalued, meaning you're paying too much; fairly valued, meaning you're paying a fair price, so outperformance might be hard to come by; or undervalued, meaning you're getting a good deal and a solid chance at outperformance. The most popular and most often cited way Wall Street goes about determining which valuation bucket — over, fair, or under — a stock falls in is a multiples-based approach. And, for the Club, that metric is the forward price to earnings (P/E) ratio. The "P" in the equation is the company's current stock price, and the "E" is the analysts' estimated earnings per share (EPS) for the next four quarters. The multiple is often referred to as the P/E, but the same naming convention applies if other metrics are being used, such as price-to-sales. We like the forward P/E because we like to see companies make actual money and grow profitability, rather than relying on just sales and the promise of earnings growth to come. For example, let's say there's a hypothetical company that is projected to earn $10 per share over the next 12 months. If you determine that you're comfortable paying 20 times those estimated earnings, that translates to a $200 stock. Now you look at your screen and see that it's currently trading at only $145 or 14.5 times earnings — to you, that stock looks undervalued and could be worth a buy if other parts of your research process check out. With the next 12 months (NTM) earnings estimate in hand, which can be obtained through data services and on CNBC's stock quote pages, how do you decide on the right P/E multiple to put on the stock. Things to consider include the growth rate of earnings — typically, a company that is growing earnings faster than a direct competitor will see its stock trade at a higher multiple. The average investor is willing to pay a premium for growth. Hence, why faster-growing Eli Lilly , a Club name riding the obesity drug boom, has commanded a significant valuation premium of roughly 58 times on average over the past 5 years, compared to the slower-growing Pfizer at around 28 times on average over the past 5 years. It's also best to compare multiples of companies within the same industry because important business attributes that can influence valuation vary wildly across different types of firms and sectors. A company like Club name Salesforce , which sells subscription-based software that customers rarely cancel, is much different than an industrial-focused company such as portfolio holding DuPont , which sees demand for its products fluctuate based on economic and industry spending cycles. The historical valuation of a stock can also help you determine the right multiple to pay now. Consider an industrial company that grew earnings 10% a year over the past five years and its stock traded at an average of 18 times forward earnings in that stretch. If it's likely to grow earnings at a slower clip in the next year because the economy is slowing down, paying 18 times earnings might not be the right move — for now, at least. But if the historical earnings growth is likely to continue and the stock is trading below an 18 multiple, it may be a buying opportunity, all else being equal. Interest rates and the general perception of risk matter a great deal in the multiples approach. If rates are higher — meaning an investor could now park their money in a safer bond fund and generate an annualized return of 4.5% versus 3% a year ago — they may not be willing to assign the same multiple to future earnings that they were before. They're demanding a higher rate of return on the stock — and, therefore, will want to pay a lower price-to-earnings multiple. Put another way, investors are not going to pay as much per dollar of earnings then they were before. The inverse is true if rates are falling. Similar dynamics are at play if it's considered to be a riskier environment, which could lead to less confidence in future earnings projections and so-called multiple compression as a result. Conversely, if investors are gaining confidence — or "visibility," in Wall Street parlance — into future earnings, they may be willing to pay a loftier multiple. Bottom line No matter the kind of market we find ourselves in, the forward P/E approach can be used to hunt for opportunities as part of a larger research process into a company. Of course, a valuation model is only as good as its inputs — so, the quality of the assumptions matters. But learning how to value a stock so you can identify when the market is getting it wrong can lead to major rewards. What investors are focused on may change from time to time — but in the end, it all comes down to how much a company will earn in the future. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
