The 7 Main Methods Of Valuation Of Shares

methods of valuation of shares

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.  Imagine you’re trying to figure out how much a company’s shares are really worth? To figure out this there are 7 key methods of valuation of shares that helps to make this process simpler.

methods of valuation of shares

The success in the financial stock market world is based upon the capability of making informed and smart decisions in ever evolving financial markets. This will only be possible after you have the right and correct information and knowledge about the methods of valuation of shares, that forms a major and crucial part of the financial world. 

For that reason, let’s dive into the methods of valuation of shares, but before that let’s know about valuation of shares!

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. 

what is valuation of shares?

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. 

Let’s start with the methods of valuation of shares!          

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

Let’s discuss one by one the above methods of valuation of shares. 

(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.

Shares value

To determine the company’s current fair value as of today, the DCF method for that discounts all future cash flows. With this method you 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. 

Share prices

(D) Price to Book (P/B) Ratio

Another ratio method in the line. 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 that’ll provide us with the actual value of shares of the company.

valuation

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 you’ll be able 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.

Shares price valuation

This ratio can help you 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.

valuation price

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.

share stock price

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: Do you know there are key objectives and functions of mutual funds that are must to know before investing in those funds? To know more about it, visit our 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!

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Published By: Aashita Singh
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