4.1 WHAT IS SHARE VALUATION?

In the simplest terms, share valuation is a system of determining the value of a business
by estimating the value of its shares.

Suppose you are the CEO of a company, and your company has decided to take over one
of its competitors. So then how do you decide the price at which the shares of the other company
must be taken over? We can even consider buying its shares at the market price (the price at
which they’re being traded) if it’s a listed entity, but how do we do so for a private company?

Therefore, in such circumstances, it is better to evaluate the net worth of the company’s ownership
through separate methods and assumptions. This evaluation is known as Share Valuation

4.2 WHEN IS VALUATION OF SHARES REQUIRED?

The valuation of shares is usually required in the following situations –
 When a business is being sold to another business;
 When a business offers its shares as security to get a loan;
 When companies undergo mergers, demergers, acquisitions or reconstruction;
 When a company is implementing an Employee Stock Option Plan (ESOP); and/or
 When a company plans to convert its shares from preference to equity shares.

4.3 HOW TO CHOOSE THE SHARE VALUATION METHOD?

There are various reasons for adopting a particular method for share valuation; it
generally depends upon the purpose of valuation. Using a combination of methods generally
provides a more reliable valuation. Let’s see under each approach what the main reason is:
4.3.1 ASSETS APPROACH
If a company is a capital-intensive company and invested a large amount in capital assets or
if the company has a large volume of capital work in progress then asset-based approach can be
used. This method is also applicable for valuing the shares during amalgamation, absorption or
liquidation of companies.
4.3.2 INCOME APPROACH
This approach has two different methods namely Discounted Cash Flow (DCF) or Price Earning
Capacity (PEC) method. DCF method uses the projection of future cash flows to determine the
fair value and if this data is reasonably available, DCF method can be used.
PEC method uses historical earnings and if an entity is not in the business for a long time and
just started its operations, then this method cannot be applied.
4.3.3 MARKET APPROACH
Under this approach, the market value of the shares is considered for valuation. However,
this approach is feasible only for listed companies whose share prices can be obtained in the
open market. If there are set of peer companies which are listed and engaged in the similar
business, then such company’s share public prices can also be used.

4.4 WHAT ARE METHODS OF SHARE VALUATION?

There is no one valuation method that will fit any purpose, hence there are various methods of
share valuation depending upon the purpose, data availability, nature and volume of the company
etc.
4.4.1 ASSET-BASED
This approach on based on the value of company’s assets and liabilities which includes
intangible assets and contingent liabilities. This approach may be very useful to manufacturers,
distributors etc where a huge volume of capital assets are used. This approach is also used as a
reasonableness check to confirm the conclusions derived under the income or market
approaches.
Here, the company’s net assets value is divided by the number of shares to arrive at the value of
each share. Following are some of the important points to be considered while valuing of shares
under to this method:

 All the asset base of the company including current assets and liabilities such as
receivables, payables, provisions should be considered.
 Fixed assets have to be considered at their realizable value.
 Valuation of goodwill as a part of intangible assets is important
  Even unrecorded assets and liabilities to be considered
 The fictitious assets such as preliminary expenses, discount on issue of shares and
debentures, accumulated losses etc. should be eliminated.

For determination of the net value of assets, deduct all the external liabilities from the total asset
value of the company. The net value of assets so determined has to be divided by the number of
equity shares for finding out the value of the share. The formula used is as follows:

    
4.4.2 INCOME-BASED
This approach is used when the valuation is done for a small number of shares. Here, the focus is
on the expected benefits from the business investment i.e what the business generates in the
future. A common method used is the estimate of a business’s value by dividing its expected
earnings by a capitalization rate. There are two other methods used such as DCF and PEC. PEC
can be used by an established entity and newly started business or companies with volatile short-
term earnings expectations can use the more complex analysis such as discounted cash flow
analysis.
Value per share is calculated on the basis of profit of the company available for distribution. This
profit can be determined by deducting reserves and taxes from net profit. Listed below are the
steps to determine the value per share under the income-based approach:

 Obtain the company’s profit (available for dividend)

 Obtain the capitalized value data
 Calculate the share value ( Capitalized value/ Number of shares)

Note:
Capitalized Value is calculated as follows:
 4.4.3 MARKET-BASED
The market-based approach generally uses the share prices of comparable public traded
companies and the asset or stock sales of comparable private companies. Data related to private
companies can be obtained from various proprietary databases available in the market. What is
more important is how to choose the comparable companies – a lot of pre-conditions to be kept
in mind while selecting such as nature and volume of the business, industry, size, financial
condition of the comparable companies, the transaction date etc.
There are two different methods when using the yield method (Yield is expected rate of return on
an investment) they are explained below:
1. Earning Yield
Shares are valued on the basis of expected earning and the normal rate of return. Under this
method, value per share is calculated using the below formula:

                                              
2. Dividend Yield
Under this method, shares are valued on the basis of expected dividend and the normal rate of
return. The value per share is calculated by applying following formula:
Expected rate of dividend = (profit available for dividend/paid up equity share capital) X
100

  
 What are the Types of Stock Valuation?
On the basis of the value derived in the methods used, there are two types of share valuations –

Absolute Valuation –
Absolute valuation is the type used to calculate the “intrinsic” value of the shares, which has
been discussed above.

This method only focuses on the fundamentals of the company – dividends, cash flow, and the
growth rate of the concerned business.

Relative Valuation –
The method under relative valuation uses ratio analysis, among others, to ascertain the value of a
stock in comparison to its peers.

The methods under this type are numerous, and are easy to use as well.

What are the Methods of Stock Valuation?

Following are some of the popular methods of share valuation –

The Assets Approach –

This approach is based on the value of company’s NAV and shares. Here, the company’s Net
Asset Value (NAV) is divided by the number of shares to arrive at the value of each share.
The Net Asset Value of a company is the difference between the net value of all the assets and
liabilities of a business.

The net value of assets determined has to be divided by the number of equity shares for finding
out the true value of the share.

Following are some of the important points to be considered while valuing shares under
this method:
 All of the assets of the company, including current assets and current liabilities such as
trade receivables and payables, provisions, etc. have to be considered.

 Fixed assets have to be considered at their realizable value.

 Valuation of goodwill as a part of intangible assets is essential to the calculation.

 The fictitious assets such as preliminary expenses, discount on issue of shares and
debentures, accumulated losses etc. should be eliminated.

The Income Approach –

 This approach focuses on the expected benefits from the business investment, i.e., what the
business generates in the future.

One of the popular methods under this approach is the Value per Share method.

Here, the value per share is calculated on the basis of the profit of the company which is
available for distribution to the shareholders. This profit can be determined by deducting reserves
and taxes from net profit.

You can follow these steps to determine the value per share:
1. Calculate the company’s profit, which is available for dividend distribution;
2. Obtain the rate of normal rate of return for the relevant industry; and
3. Calculate the capitalized value as (profit for distribution*100/rate of return)
4. Divide this value by the number of shares.
What are the Factors Affecting Valuation of Share?

1. Demand and supply

Demand and supply of securities influence price of securities. If the demand of securities is more
than the supply (buyers are more than the sellers), prices of securities increase. On the other hand
if the demand of securities is less than the supply (buyers are less than the sellers), prices of
securities decrease.

2. Bank rate
In case of lower bank rate (lower interest rate), the demand for funds would be higher and the
demand for securities would he high. Whereas in case of higher bank rate (high interest rate). the
demand for funds would be lower and therefore the demand for securities would be lower.

3. Market players
Security prices are influenced by the market players. If the number of bulls are more than the
bears, then the prices of securities would increase. On the other hand, if the bears are more than
the bulls, the prices of securities would decline.

4. Dividend announcements
Dividends act as a signalling device for share price movement. Dividend announcements
influence share prices. If companies announce dividends, generally share prices of those
companies tend to increase. An important point to note is, if the rate of dividend announced is
less than what was expected by investors, share prices would decline, whereas if they are up to
are more than expectations. share prices would increase.
5. Management profile
Management profile significantly influences success of companies and therefore they have an
important influence on share prices. If the management comprises of educated, experienced
professionals with a successful track record then share prices would be higher. In case the
company is taken over by a management having a poor reputation then the share prices would
fall.

6. Trade cycle
Trade cycles refer to cyclical fluctuations in economic activity. During boom conditions the
share prices would be at their peak and during depression they would be at their lowest point.
Share prices would gradually increase during recovery conditions and would fall during
conditions of recession.

7. Speculation
In case speculation in the market is high or in case speculation in a stock is high, then the price
of that share would be showing high fluctuations. In case speculation is at a low level then the
fluctuations in share price would be lower.

8. Political factors
Political factors such as ideology of the party in power, policies of the government, relations
with other countries influence share prices. For e.g. when the UPA government won elections,
share prices fell to a great extent because it was felt that the government policies would be
influenced by the communist parties.

9. Industrial relations
In case there is good relationship between the workers and the management of a company, the
productivity would be high leading to better profits. Therefore share prices would be higher. In
case of companies where industrial relations are poor and strikes and lockouts occur regularly,
performance of the company would be poor. Therefore share prices would fall.

10. Stability of government

When there is a stable government, businessmen feel confident to invest in new businesses and
expand existing businesses. Production, sales and profits are higher and consequently share
prices would increase. In case of instability in the government, new investments do not take
place. Demand, production and profits are lower and share prices fall.

11. General market sentiments

It is generally said that sentiments move the markets. If there is optimism among market players,
more buying would take place leading to increase in share prices. In case market players are
pessimistic, then more selling would take place pushing down share prices.
12. Actions of institutional investors
Share prices are influenced by Institutional investors such as mutual funds, investment trusts,
pension funds etc. They have large amount of funds at their disposal. When they start buying,
share prices would increase and when they sell, share prices decline

13. Availability of credit

In case credit is available without much restriction, then investors would borrow to invest in the
markets. Demand for shares would be more and therefore prices rise. In case credit is restricted,
then the level of borrowing would be less and demand for shares would also be lower.

14. Effective regulation

If the stock market is run in a transparent manner with effective regulation then the investors
would feel confident to invest. Therefore more buying would take place and share prices
increase. But when regulation is ineffective and if scams occur (Harshad Mehta scam, MS Shoes
scam, CRB scam, Ketan Parekh scam and the recent IPO scam) investors would lose confidence.
They would panic and sell their shares. So prices would fall.

Share Valuation means to find the intrinsic or true value of an investment based only on
dividends, cash flow and growth rate for a single company. Shares are ownership in a
corporation. It has a certain face value, commonly known as the par value of a
share/stock. Ownership of shares is documented by issuance of a stock certificate. A share
certificate is a legal document that specifies the amount of shares owned by the shareholder, and
other information of the stock, such as the par value, the class of the shares etc.
Type of Shares
There are two types of Share i.e. Preference Stock and Common / Equity Stocks:
 
Preference Share
Pay regular fixed dividend and ownership of the company. Hybrid form of shares because it has
equity feature of ownership and debt feature of fixed return. Preference share may be perpetual
or redeemable:
 
Preference Share Valuation
Use same equation of Bond valuation:
 
Formula

Example 1:
Considered that 8 year, 10 percent dividend preference stock with a par value of Rs. 1,000. The
required rate of return on this preference stock is 9 percent. What is the value of this share?

 
Share Valuation (Redeemable)
Shares are also called stock or common stock. Ownership of the corporation with flexible or
floating return. Valuation is based on the same principle of Present Value as bonds, but there are
some complications. Uncertainty associated with future cash flows in the forms of dividends and
share price. Difficulty in determining an appropriate discount rate.

 
Single Period Valuation Model
Valuation is depend upon the a year of dividend and after one year sell of shares:

 
Example 2:
ABC equity share expected to provide a dividend of Rs. 2.00 and market price of Rs. 18 a year
hence. What price would it sell for now if investors’ required rate of return is 12 percent?

 
Multi-Period Valuation Model
Valuation is depend upon more than one year of dividend and after that selling price of shares:
 
Example 3:
Mr. Ali held 20 share of par value of Rs. 100 each. Dividend for first, second and third year are
expected in the amount of Rs. 3, 4 and 5.50 per share respectively and after that share redeemed
at face value. Calculate the value of stock if discount rate is 13 %?

 
Share Valuation (Irredeemable)
There are several methods (models) to assess the value of a stock whose selling price is not
known. Valuation are done on the basis of dividend:
 
Dividend Discount Model (DDM)
DDM used compute the intrinsic value of common shares. When time is too long the value of
stock depends upon Present value of dividend. Dividend paid annually and first Dividend
received one year after the equity share is bought. To compute the value of the stock, all
expected future dividend payments are discounted at an appropriate rate to the Present Value:
 
Dividend Discount Model (Zero Growth)
Cash flow pattern of zero growth stock is like perpetuity. If we assume that the dividend
payments will remain constant then the formula could be written as:

 
Example 4:
A stock pays a Rs. 12 dividend annually.  If your opportunity cost is 15%, how much is this
stock worth to you?

 
Dividend Discount Model (Unlimited Constant Growth)
This model assumes that the dividend payments are growing each year at a constant rate of “g”
forever:

 
Example 5:
Suppose you want to buy a share of Swiss Farms. Swiss Farms paid a recent dividend at an
annual rate of Rs. 2.00 per common share.  After talking to your broker, you expect the
dividends to continue to increase at 5% per year, like the past four years.  Your opportunity cost
is 12%.  What is this stock worth to you?

 
Dividend Discount Model (Limited Constant Growth)
This model assumes that the dividend payments are growing each year at a constant rate of “g”
for limited time

 
Example 6:
Suppose that Sun Corporation’s dividends this year is Rs. 1.20 per share and that dividends will
grow at 10% per year for the next three years, the appropriate discount rate for Corporation’s
common stock is 12%.  What is the value of a share?

 
Dividend Discount Model (Mixed Growth)
This model assumes that the company and its dividend payments grow much faster than the
economy for a certain period at the beginning and then settles to a constant growth rate.
 
Example 7:
Suppose that Sun Corporation’s dividends this year is Rs. 1.20 per share and that dividends will
grow at 10% per year for the next three years, followed by a 6% annual growth rate.  The
appropriate discount rate for Corporation’s common stock is 12%.  What is the value of a share
of Sun Corporation common stock?
 
Method 1

 
Method 2
 
Method 3

Shares Pricing

The golden rule is ‘buy low, sell high’.

 
Expected Rate of Return with Growth

 
Example 8:
The expected dividend per share of Habib Bank Ltd. is Rs. 5; the dividend is expected to grow at
the rate of 6 percent per year. If the price per share now is Rs. 50, what is the expected rate of
return?

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