Understanding the true value and assessing the worth of a company’s shares is crucial for the investors and the budding financials enthusiasts individuals alike. To figure out this there are 7 key methods of valuation of shares that helps to make this process simpler.
What is Valuation Of Shares?
Valuation of shares refers to the process of determining the fair value or worth of a company’s stock. The process involves various factors and using different methods to estimate the true and intrinsic value of shares, helping investors to make informed decisions.
For this the analyst or financial researchers use the company’s financial statements and information, like, market capitalization, structure, cash flows, current earnings, etc. to determine the company’s true value. By analyzing its true value, the shares of the company are either valued or undervalued while thinking of investing in mutual funds.
Methods Of Valuation of Shares
(A) Discounted Cash Flow (DCF) Methods
(B) Asset Based Valuation
(C) Price to Earnings (P/E) Ratio
(D) Price to Book (P/B) Ratio
(E) Dividend Discount Model
(F) EV/EBITDA
(G) Market Price Method
(A) Discounted Cash Flow (DCF) Method
This method is widely used, especially the cash flows generated by the government. This method is a widely used intrinsic valuation method. It involves factors like discounted cash flow methods.
It is an income-based valuation method. This method is considered to be one of the best value indicator . It is a popular metric in the industry to value companies of different sizes from different industries.
To determine the company’s current fair value as of today, the DCF method for that discounts all future cash flows. With this method people can even predict future cash flows for five to ten years to find out the company’s true value.
After that, calculate the terminal value of account for all future cash flows beyond the determined period. Then discount all these cash flows to the estimate of present day to determine the company’s true value.
(B) Asset Based Valuation
Under this method, the company’s assets and liabilities are valued. This method analyzes and considers all types of assets and liabilities, be it the tangible, intangible assets or the possible or unforeseen liabilities.
First step is to determine the net asset value in order to calculate the share value, and after that subtract the preference share number from the difference above and divide it by the total number of shares to get allotted with the value per share.
Value per share = (Net Assets – Preference capital) / Number of equity shares
This method is most suitable for industries or businesses that have significant assets holdings, like real estate or manufacturing.
(C) Price to Earnings (P/E) Ratio
It is a major metric assessment tool for market valuations or to determine the value of a stock or share price. This method is most commonly used by companies of relatively the same size and belong to the same industry. This (P/E) ratio indicates how much an investor is ready to pay for Rs.1 of earnings.
A high value of P/E ratio indicates that the shares are overvalued and a low value of it indicates that the shares are undervalued.
This ratio can easily help in determining the fair and right values of shares and can compare it to its earnings and industry averages.
(D) Price to Book (P/B) Ratio
This is the ratio between the company’s market value and book value. While the company’s book value is referred to the value of assets from the date after accounting for depreciation, on the other hand the share price is simply the market value of the company.
A good and better ratio of P/B means that value is below 1, while one must also consider the company’s current fundamentals and financials for using this ratio for the valuation process.
(E) Dividend Discount Model
This method uses dividends to calculate the company’s intrinsic value. A simple and direct method for valuation of shares.
The dividends are predominantly used because those are the cashflows to the shareholders, and becomes easier in calculating and finding out the current value of all the future cashflows. It will provide the actual value of shares of the company.
The first step to look after here is, determine or check whether the company pays a dividend or not. After that look for, if those dividends are stable and likely. And if all these conditions are there, then only it is possible to calculate the valuation of shares by this method.
(F) EV/EBITDA
The acronyms used for the Enterprise value / Earning before interest, taxes, depreciation, and amortization ration. This refers to the measure of calculating the estimated value of the company by using its profitability factor and market value.
Company’s total value is described by Enterprise value, which can be calculated by using numbers of market cap, cash or cash equivalents, and total debt. While on the other hand the EBITDA is the measure of a company’s profits that comes out from its sales of its goods and services.
This ratio can help to get the experience of a professional financial buyer. While this ratio can serve different purposes in multiple industries, a high EV is recommended for the high growth efficient company, while low steady growth companies usually have a low EV ratio.
(G) Market Price Method
This method simply uses the current market price for evaluating the valuation of shares. One of the most commonly used methods of valuation of shares. It focusses and relies on one simple aspect, i.e. on the principles of supply and demand & then represents the whole collective take or opinion of market participants.
However, there are some factors due to which market price can be affected or fluctuate, the factors can be the company performance, economic scenario, market trends, dynamic price range, industry ways, etc.
For this the investors can compare the market prices to different valuation criteria like P/B ratio or P/E ratio, etc. Furthermore, it is essential to consider the fundamental factors like growth aspects, financial stability, etc. as these factors can or may have a direct effect on a company’s performance.
Factors affecting valuation of shares
There are several factors that can affect valuation of shares of a company, like financials of a company, its market prices, economic value, higher profits, etc.
Some of them are listed below-
Company’s financials: Valuation can be impacted by how good the company is performing, such as profits, cashflows, dividends, sales growth, assets, etc. contributes to factors affecting valuation of its shares.
Competitive Landscape: Another factor that can be accountable for affecting valuation of shares is the competitive position of the company in the competitive landscape. It can be affected by its market share, competitive advantage, and position in the industry.
Market price: These prices play a pivotal role in determining the valuation of the shares of a company. It considers factors such as P/E and P/B ratio value of the company’s share prices, which depends on the demand and supply of shares, share performance, and the market sentiment.
Economic conditions: The country’s economic conditions become one of the factors that could affect valuation of shares. Like, in an economic slowdown environment, the interest rates are high, along with that the inflation is high, and the demand in the market is low.
Then in such conditions, it can affect the company’s short and medium-term performance. The valuation of the company varies in the short and medium term.
Note: Visit the article Key Objectives & Functions of Mutual Funds.
Summing Up
In conclusion, it becomes crucial for the investors to understand the methods of valuation of shares as it becomes a helping hand in determining and evaluating shares price value.
It serves as the route for the investors to look for different opportunities according to the method opted by the valuation of shares and look for the successful results.
Selecting the right and correct method of valuation of shares helps in navigating the complex landscape of finance!
