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 networth of the company’s

ownership through separate methods and assumptions.

This evaluation is known as Share Valuation

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 undergoes 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.

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:
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.

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.

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.

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.

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:

    

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:
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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