Share Valuation

Methods of Shares Valuation

 The most common methods of valuing
shares are:
a) b) c) d) e) f)
Earnings (P/E ratio) Accounting rate of return Net Assets Dividend yield Super profits Discounted Cash Flow based valuation

 Issues in share valuation

The method(s) of valuation chosen will depend on the following issues: 1. Is the company going concern? If not,
only break up value is required future earnings are irrelevant 2. Perspective of valuation ie. Buyers or Sellers 3. Is the company listed? Unlisted companies are valued at a discount against similar listed companies

1) The P/E Ratio (earnings) method of

valuation:
Since P/E Ratio = Market Value per share /EPS or Earning yields = EPS / Market value per share Market Value per share = P/E ratio x EPS

Problems with using price earnings multiples:

 The calculation of the future earning figure

is arbitrary  Selecting a suitable P/E ratio is difficult  Any discounting of the selected P/E ratio of a listed company is arbitrary

2) The Accounting rate of return (ARR) method of

share valuation: Value of the company = Estimated future earnings / Required rate of return on capital employed Problems associated with ARR:

a) It is difficult to calculate an accurate figure for post

acquisition profit b) The method does not take account of future growth in profits

3) The net assets method of share valuation:

Value of share = net tangible assets/ no of equity shares Intangible assets should be excluded unless it has a market value for example Patents and Copy rights which can be sold.

4) The dividend yield method of share valuation:

The simplest dividend capitalisation technique is based on the assumption that the level of dividends in future will be constant. Value per share = Dividend per share / Expected dividend yield If expected future dividend is assumed to grow then: Dividend growth model for share valuation should be used ie.: MV = do (1+g)/ (r-g) (rWhere: MV = Market value of share Do = Current dividend g = expected annual growth in dividend do(1+g) = expected dividend next year r = the required rate of return

5) The Super profits method of share

valuation:
This method starts by applying a fair return to the net tangible assets and comparing the result with actual profits, any excess of profits (called super profits) is used to calculate goodwill. The goodwill is normally taken as a fixed number of years super profits Value of company = goodwill (arrived as above) + net tangible assets

6) The discounted future earnings of

share valuation: It is the sum of Estimated future earnings discounted by appropriate rate of return. Problems associated with this method are: a) Difficulty of predicting future cash flows b) Problem of choosing an appropriate discount rate.

Practice Question