Valuation of shares

Group 9

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Valuation of shares

What is a Share & how it is operated in the stock market?

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Need for valuation?

When two or more companies amalgamate

01

When absorption of a company takes place.

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When shares are held by the partners jointly in a company and dissolution takes place., it becomes necessary

to value the shares for proper distribution of partnership property among the partners.

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When a portion of shares is to be given by a member of proprietary company to another member, fair price of these shares has to be

made by an auditor or accountant.

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When some shareholders do not give their consent for reconstruction of the company, there shares are

valued for the purpose of acquisition.

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Equity shares

Permanent capital

No obligation

Voting rightsRate of dividend

Equity share capital remains permanently with the company. It is returned only when the company is wound up.

Equity shareholders have voting rights and elect the management of the company.

The rate of dividend on equity capital depends upon the availability of surplus funds. There is no fixed rate of dividend on equity capital.

Equity shares do not create any obligation to pay a fixed rate of dividend.

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Preference shares

Long term

No voting rights

EPS not dilutedIncreased earnings

Preference shares are long-term source of finance

The earnings per share of existing preference shareholders are not diluted if fresh preference shares are issued

Issue of preference shares increases the earnings of equity shareholders, i.e. it has a leveraging benefit.

Preference shareholders do not have any voting rights and hence do not affect the decision mak ing of the company.

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Net Asset based Method

Average Profit= (Total profit/no. of year)

Net Asset= Fixed asset + C.A - C.L - Long term borrowing

Normal Profit = Capital employed*Normal rate of return

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Net asset based method

Super profit = Average profit – Normal profit

Goodwill = Super profit * No. of years Purchase

Value of shares = (Net asset + goodwill)/(No. of equity shares)

Single period Valuation

Only one period is assumed and for convenience this one period is set equal to one year. Using the discounted cash flow approach for valuation of equity the current price of equity share, P0 is equal to the dividend expected during the holding period, D1 and the price of the asset at the end of the holding period P1.

Multi period valuation

DDM with Constant Dividend – No Growth

If a) earnings remain constant period after period and b) all earnings, E are distributed then earnings would be equal to dividend and all dividend would be equal.

Multi period valuation

DDM with Constant Growth

If part of the earnings are retained & deployed in business and result in growth of earnings and hence dividend in future periods. If we simply assume that dividend grows at a constant rate of g,

Here dividend in next period is D. For convenience we may denote it by D1 = D0(1+g) the dividend in Period 1. The dividend in subsequent period 2 is D1 x (1+g) and in period thereafter is D1 x (1+g) x (1+g) = D1(1+g)2 and so on

Multi period valuation DDM - MULTI-STAGE GROWTH MODELS

Valuation based on constant growth of dividend is a greatly simplifying assumption that helps explain some of the complex phenomena of the share price valuation. However, it seems rather unrealistic that the firm would continue to grow at the same rate forever. A more reasonable and realistic assumption would be to assume high growth during the initial few years. Thereafter as opportunities for extra-ordinary growth opportunities dry up, competition catches up and firms start registering a rather normal growth consistent with the rest of the economy.

When trying to figure out which valuation method to use to value a stock for the first time, most investors will quickly discover the

overwhelming number of valuation techniques available to them today. There are the simple-to-use ones, such as the comparable method, and there are the more involved methods, such as the discounted cash flow

model. Which one should you use?