by The Fair Value Method of share valuation determines the worth of a share by averaging the Intrinsic Value Method and the Yield Method. It provides a balanced valuation by considering both the assets of the company and its profit-generating ability. The formula used is:
Fair Value per Share = [Intrinsic Value + Yield Value] / 2
This method ensures that neither the book value of assets nor the earning potential is solely relied upon. It is widely used in cases of mergers, acquisitions, and investment decisions where a realistic valuation of shares is required. The Fair Value Method is more comprehensive than standalone methods, making it ideal for determining the true market worth of a company. However, its accuracy depends on reliable financial data and stable market conditions to ensure a fair and justifiable valuation.
Assumptions of Fair Value Method:
-
Combination of Intrinsic and Yield Value
The Fair Value Method assumes that the true value of shares lies between the Intrinsic Value (based on assets) and the Yield Value (based on earnings). By taking the average of both, it ensures a balanced valuation approach. This assumption is crucial because relying on just one method may not provide an accurate estimate of the share’s worth, especially in fluctuating market conditions.
-
Stable Market and Economic Conditions
The method assumes that the market conditions, economic environment, and industry trends remain relatively stable over time. Sudden changes, such as recessions, inflation, or policy changes, can affect both the intrinsic and yield values, making the fair value less reliable. This assumption helps in maintaining consistency and predictability in share valuation.
-
No Significant Business Disruptions
It assumes that the company’s business operations will continue smoothly without major disruptions like bankruptcy, litigation, or regulatory penalties. If the company faces serious operational or financial difficulties, the valuation derived using the Fair Value Method may not reflect the actual market scenario. Investors and analysts use this assumption to maintain a consistent valuation framework.
-
Reliable Financial Data is Available
The accuracy of the Fair Value Method depends on the availability of reliable and audited financial statements. It assumes that the balance sheet, profit and loss statements, and earnings reports are free from manipulation or errors. Any discrepancies or misreporting in financial data can lead to an incorrect fair value assessment, affecting investor confidence.
-
No Drastic Changes in Future Earnings or Asset Value
The method assumes that the company’s future earnings potential and asset values will not change drastically. It does not account for unforeseen events like major technological advancements, industry shifts, or external economic crises. This assumption ensures that fair value remains stable and provides a reliable benchmark for investors and stakeholders.
