{"id":25232,"date":"2019-10-03T17:19:54","date_gmt":"2019-10-03T11:49:54","guid":{"rendered":"https:\/\/enterslice.com\/learning\/?p=25232"},"modified":"2019-10-05T12:59:01","modified_gmt":"2019-10-05T07:29:01","slug":"the-concept-of-share-valuation-of-companies","status":"publish","type":"post","link":"https:\/\/enterslice.com\/learning\/the-concept-of-share-valuation-of-companies\/","title":{"rendered":"The Concept of Share Valuation of Companies"},"content":{"rendered":"<p class=\"has-drop-cap\">The valuation of shares involves finding out the value of a company&rsquo;s\nshares. The share value of the listed entity whose shares are floating and\ntraded on the stock <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Market&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;A market is a structured environment, either physical or virtual, where buyers and sellers convene to trade goods and services. This trading hub operates based on the principles of supply and(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/market\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>market<\/a> can be evaluated easily. Valuation of Shares varies\ndepending upon the demand and supply of shares\nin the market, and the valuation is done based\non quantitative techniques. However, in the case\nof private companies,\nwhose shares are not publicly traded, the valuation of shares becomes difficult and challenging.&nbsp;\n<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>The Requirement of Share Valuation<\/strong><\/h2>\n\n\n\n<p><strong>Share Valuation is required in case of the following incidences:<\/strong><\/p>\n\n\n\n<ul><li>When a company is on the verge of being sold and the buyer as well as the company, need to know the actual worth of the company&rsquo;s business in terms of the value of its shares.<\/li><li>For obtaining loans from a bank by creating a charge on shares as a security.<\/li><li>In case of a merger, amalgamation, takeovers, acquisition, etc.<\/li><li>In the case of the conversion from preference shares to equity shares.<\/li><li>When the company issues shares through Employee Stock Option Plan (ESOP).<\/li><li>For tax assessments to be conducted under the <strong>Gift Tax Act<\/strong><sup><a href=\"https:\/\/en.wikipedia.org\/wiki\/Gift_Tax_Act,_1958\">[1]<\/a><\/sup>.<\/li><li>As a legal requirement, for instance, in the case of litigation.<\/li><\/ul>\n\n\n\n<div class=\"shadow1\"><i>It is important to note that market quotation does not always present the accurate picture of the value of shares and that&rsquo;s why sometimes the valuation of publicly traded shares is also required to be conducted using a suitable approach and methods as explained in detail in the article henceforth.<\/i><\/div>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>The Approach to Share Valuation<\/strong><\/h2>\n\n\n\n<p>The selection of a\nsuitable method for\nshare valuation generally depends upon the purpose of\nsuch valuation. Combining two or more methods for the valuation of shares\nprovides a more reliable valuation. Following are the approaches usually\nresorted to: <\/p>\n\n\n\n<ol><li><strong>Asset Approach:<\/strong> Asset-based approach is used in case the company is:<\/li><li>Capital-Intensive; or<\/li><li>Has Invested large\namount in capital assets; or<\/li><li>Has the large volume of\ncapital work in progress <\/li><\/ol>\n\n\n\n<p>Other than the above,\nthis approach is applied by a company for the valuation of shares, in case the\ncompany is undergoing amalgamation, merger, or absorption.<\/p>\n\n\n\n<ul><li><strong>Income Approach<\/strong>: Following two methods are used to evaluate the shares under this approach:<\/li><li><strong>Discounted Cash Flow Method: <\/strong>The value of shares is determined based on the projection of future cash flow.&nbsp; <\/li><li><strong>Price Earning Capacity Method: <\/strong>This method makes use of the historical earning pattern to value the shares. This method is, however, not feasible for an entity that has not been in existence for a long time. <\/li><\/ul>\n\n\n\n<ul><li><strong>Market Approach: <\/strong>This approach is more feasible for the listed entity whose shares\nare listed and traded on the stock market because as per this approach, shares\nare valued based on the prevailing market price of shares.<\/li><\/ul>\n\n\n\n<div class=\"read\"><p><b>Read Also:<\/b> <mark><a href=\"https:\/\/enterslice.com\/learning\/method-business-valuation-india\/\" target=\"_blank\" rel=\"noopener noreferrer\">Methods of Business Valuation in India<\/a><\/mark>.<\/p><\/div>\n\n\n\n<h2 class=\"wp-block-heading\"><strong>Methods of Share Valuation<\/strong><\/h2>\n\n\n\n<p>Different methods for valuation\nof shares can be used depending upon the purpose, the available data, nature of the company, etc.: <\/p>\n\n\n\n<ol><li><strong>Asset-Based Method:<\/strong> This method of valuation is based on the value of the company&rsquo;s\nassets &amp; liabilities inclusive of intangible assets &amp; contingent\nliabilities. This\nmethod is useful in entities engaged in manufacturing, distribution, etc. as\nthey are engaged in a huge volume of a capital asset.<\/li><\/ol>\n\n\n\n<p><strong>Value per Share = &nbsp;&nbsp;&nbsp; <u>Net Assets &ndash; Preference Share Capital<\/u><\/strong><\/p>\n<p><strong>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;Number of Equity Shares<\/strong><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Key- Points of Consideration:<\/strong><\/h3>\n\n\n\n<ul><li>All the current assets and liabilities such as receivables,\npayable, provisions, etc. should be considered<\/li><li>Fixed assets are considered at their realized value<\/li><li>It is important to evaluate intangible assets such as goodwill.<\/li><li>Unrecorded assets and liabilities are also considered<\/li><li>No fictitious asset shall be considered. Preliminary expenses,\ndiscount on issue of debentures, accumulated loss, etc. are called a fictitious\nasset.<\/li><li>All the external liabilities are deducted from the total assets to\ncalculate the Net Assets.<\/li><\/ul>\n\n\n\n<p><strong>2. Income-Based Method: <\/strong>This method is used when a very small number of shares are required to be evaluated. The main focus is on what the business will generate in the future. Business value is estimated by dividing the expected earnings by a capitalization rate. The value of shares is calculated based on the profit of the company available for distribution. Gross profit is calculated by deducting reserves and tax from net profit. <\/p>\n\n\n\n<p><strong>Value of Shares =&nbsp; &nbsp; &nbsp; &nbsp;<u>Capitalized Value<\/u> <\/strong><\/p>\n<p><strong>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;Number of Shares<\/strong><\/p>\n\n\n\n<p><strong>Capitalized Value = Profit available for Dividend &nbsp;<\/strong><\/p>\n<p><strong>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;__________________________&nbsp;&nbsp;&nbsp;&nbsp; <\/strong>x<strong>&nbsp; <\/strong><strong>100<\/strong><\/p>\n<p><strong>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<\/strong><strong>&nbsp; &nbsp; Normal Rate of Return&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; <\/strong><\/p>\n\n\n\n<p><strong>3. Market-Based Method: <\/strong>Following are the two methods of market-based valuation of shares:<\/p>\n\n\n\n<ul><li><strong>&nbsp;Earning Yield Method: <\/strong>As per\nthis method, the value of a share is calculated based on the expected earning\nand the normal rate of return. The formula used for it is:<\/li><\/ul>\n\n\n\n<p class=\"m-0\">1) Value per Share = &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; Expected rate of earning&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n<p class=\"m-0\">&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; ______________________&nbsp;&nbsp; &nbsp;x Paid-up Equity Value<\/p>\n<p class=\"m-0\">&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;Normal Rate of Return&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n<p>2) Expected rate of earning&nbsp;&nbsp;&nbsp;&nbsp; =&nbsp; &nbsp; &nbsp; &nbsp; &nbsp;Profit after tax&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n<p>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; ____________&nbsp; &nbsp; &nbsp; &nbsp;X 100<\/p>\n<p>&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; Paid-up Equity Value&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n\n\n\n<ul><li><strong>Dividend Yield Method: <\/strong>As per\nthis method, the valuation of shares is done based on expected dividend and normal rate or return as per the following formula:<\/li><\/ul>\n\n\n\n<p>1) Value per Share = &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; <u>&nbsp;&nbsp;&nbsp;&nbsp;Expected Dividend<\/u>&nbsp;&nbsp;&nbsp;&nbsp; X Paid-up Equity Value<\/p>\n<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; &nbsp; Normal Rate of Return&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n<p>2) Expected rate of dividend&nbsp;&nbsp;&nbsp;&nbsp; = &nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; <u>Profit available for Dividend <\/u>&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n<p>&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp; X 100&nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp; &nbsp;Paid-up Equity Value&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;&nbsp;<\/p>\n\n\n\n<p><strong>Book Value of Equity per Share<\/strong><\/p>\n\n\n\n<p>Book Value is different from the\nmarket value in terms that book value uses the historical cost while market\nvalue is a forward-looking mechanism that considers the future earning\npotential of a company.<\/p>\n\n\n\n<p>The book value of\nsecurities is compared with that of market value to ascertain whether the price\nis overvalued or undervalued. In case the book value of shares is higher than\nthe market value of shares, the stock price is said to be undervalued.<\/p>\n\n\n\n<p>In the event of\nliquidation, when all the assets are sold, and the liabilities are paid,\nshareholders get the book value for their holdings. All the assets would be\nsold at the market price which is the\nprevailing price in the market, and therefore the market price is considered as\na better floor price as compared to book value(that uses the historical cost of\nassets).<\/p>\n\n\n\n<p><strong>Key-Points<\/strong><\/p>\n\n\n\n<ul><li>The book value of assets indicates the net asset value. Net asset value is the difference between the total assets and total liabilities on a per-share <a class=\"glossaryLink\"  aria-describedby=\"tt\"  data-cmtooltip=\"&lt;div class=glossaryItemTitle&gt;Basis&lt;\/div&gt;&lt;div class=glossaryItemBody&gt;In finance, the &amp;quot;basis&amp;quot; is a term with several applications, including representing the difference between the spot price and the future contract price of an asset, which is vital in investment(...)&lt;\/div&gt;\"  href=\"https:\/\/enterslice.com\/learning\/terms\/basis\/\"  data-gt-translate-attributes='[{\"attribute\":\"data-cmtooltip\", \"format\":\"html\"}]'>basis<\/a>.<\/li><li><em>In case the stock is undervalued, <\/em>book value will be higher as compared to the current market price.<\/li><li>The method is used by investors to evaluate the company&rsquo;s current stock price.<\/li><\/ul>\n\n\n\n<div class=\"read\"><p><b>Also, Read:<\/b> <mark><a href=\"https:\/\/enterslice.com\/learning\/business-valuation-method\/\" target=\"_blank\" rel=\"noopener noreferrer\">Brief on business valuation methods in India<\/a><\/mark>.<\/p><\/div>\n\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>The valuation of shares involves finding out the value of a company&rsquo;s shares. The share value of the listed entity whose shares are floating and traded on the stock market can be evaluated easily. Valuation of Shares varies depending upon the demand and supply of shares in the market, and the valuation is done based [&hellip;]<\/p>\n","protected":false},"author":24,"featured_media":25247,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[1],"tags":[2774],"acf":{"service_id":"220"},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v14.6.1 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>The Concept of Share Valuation of Companies - Enterslice<\/title>\n<meta name=\"description\" content=\"The Share Valuation of a company is important to determine the worth of the entity for investors and shareholders. 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