Methodology: Valuation of Equity Shares

Valuation of Equity becomes easy when the shares of the Company are listed, generally in most of the cases the pricing of the shares based upon:

a) the average of the weekly high and low of the closing prices of the related equity shares during last six months preceding the relevant date; or

b) the average of the weekly high and low of the closing prices of the related equity shares during the two weeks preceding the relevant date.

 

Since market price is readily available in stock exchange website. Further we can average out the daily closing market price of last one year to make it full proof, however it becomes challenge to value unlisted companies equity shares or Companies whose shares are not regularly trade.

So, how can an unlisted equity be valued, let's learn this in detail:

Methodologies-

1. Net Asset Value (NAV) Method

2. Discounted Cash Flow Method

3. Profit or Dividend Yield Method

4. PE Ratio Method

1. Net Asset Value (NAV) Method

Net Asset represent Net worth of the Company. After reduction of preference share Capital value from net worth of the Company we get value of company to the Equity share holders. Figures of net assets from last audited balance sheet can be taken.

Important Notes -

• Value of Assets can be modify from audited figures by taking market value of Properties, Listed Investments etc.
• Rules 11UA of Income tax Rules allows only audited balance sheet figures for valuation of equity shares by net assets value method, however value of Liability will not include provisions made for meeting liabilities, other than ascertained liabilities like provision for gratuity & others and net provision for taxation.
• Partly paid up shares should be made equivalent to fully paid up shares by reducing in numbers in proportion to their lesser paid up amount.

2. Discounted Cash Flow Method (DCF)

Discounted Cash Flow Method (DCF) is a complex calculation however it considers not just Companies present situation but also take in to figure, future of the Company. DCF also works for start-up Companies Valuations which do not have track records but has valuation based on business idea & current resources.

Value of firm derived by discounting future cash flows to the company by expected rate of return of Equity & Debt holders. Valuation through DCF imbibe expectation of owners & lenders by considering expected rate of return of both Equity & Debt holders.

DCF becomes more relevant since any decision related to investment is taken considering future return on it & DCF figures out valuation based on future cash flows of the Company.

Process of valuation is as under –

Step 1: Arrive at Projected Profit after Tax

Step 2: Add back non-cash costs i.e. depreciation etc

Step 3: Subtract capital expenditures.

Step 4: Subtract Increases in working capital.

Step 5: Take into account the effect of changes in Debts.

Step 6: Discount the FCFF for each year at the cost of capital.

Step 7: Add the terminal value accruing in the final year.

Step 8: Arrive value of Equity by subtracting debt value.

Step 9: Arrive Value of Equity Share by diving number of shares to value of Equity.

Cost of Capital can be calculated as specified below –

Equity Share Holders' expected rate of return vary from industry to industry which can be calculated by adding extra return for taking industry specific risk to market expected rate of return.

Technically its equals to Beta*(Expected Return- Risk free return) + Risk free Return

Debt Holder expected rate of return would be after tax interest rate on debt.

and cost of capital is derived by weighted averaging the above rates of return as per total value of Capital & Debt.

Some more lesser use methods:

3. Profit OR Divided Yield Method

Profit after tax or dividend is divided by Normal rate of return to derive Capitalized Value & the same is divided by number of shares to get value per share.

Capitalize Value = ( Profit / Dividend ) / Normal Rate of Return

Value per Share = Capitalize Value / Number of shares

Generally We take Average profit of 5 years to rule out higher or lower side valuation.

Preference Share Dividend to be subtracted from profit to find profit attributable to equity share holders.

4. Price-Earnings Ratio Method

This method is generally used to calculate listed Company Share Value. It uses Earning Per Share (EPS) & Market Price of Share (MPS) to calculate value of share.

PE Ratio is determined as follow- MPS/ EPS

Investor can average out PE Ratio Companies in same sector to rule out higher or lower side valuation based on one company data.

Value per share – EPS x P/E Ratio

Whenever Company declare its Qrtly results & EPS, Investor by using particular sector PE Ratio can find Value of Share to take investment decision.

Selection of Method Decision

Discounted Cash Flow Method & Net Assets Value Method are the most used methods to value Shares since both method uses wide range of data & capture lot of figures to derive Value of Share.

It is always advisable to Value Share by Earning OR Market Based Method i.e. Discounted Cash Flow Method for Companies in to Manufacturing & Service. Net Asset Value Method is used by Investment Companies.

Valuation by Earning & Market based method can be cross check by other method.

Valuation Reports in Actual

Valuation report of S Chand and group companies Link

Valuation report of Tata Power by PWC Link