Methods of Valuations of Share

Valuation of shares refers to the process of determining the intrinsic or fair value of a company’s shares. Since market prices may not always reflect the true worth of shares, especially in the case of unquoted companies, different valuation methods are adopted depending on the purpose of valuation and nature of the business.

The important methods of valuation of shares are explained below:

1. Net Asset Value Method (Asset Backing Method)

The Net Asset Value Method determines the value of a company’s shares based on the net value of its assets after deducting liabilities. Under this method, the assets and liabilities are valued according to the applicable valuation basis, and the remaining amount is divided by the number of outstanding equity shares. This method is particularly useful for asset-intensive companies, investment companies, and businesses being liquidated. However, it may not fully reflect the company’s future earning capacity, goodwill, or growth potential.

Formula: Value per Equity Share = Net Assets available to Equity Shareholders / Number of Equity Shares

This method is suitable when the company is being wound up or where assets play a major role. However, it ignores earning capacity.

2. Yield Method (Earnings / Profit-Earning Capacity Method)

The Yield Method values shares based on the earning capacity of the company. It compares the company’s earnings with the normal rate of return prevailing in the industry. Expected maintainable profits are capitalized to determine share value.

Formula:

Value per Share = (Earnings per Share × 100) / Normal Rate of Return

This method is suitable for going concerns and emphasizes profitability rather than assets.

3. Dividend Yield Method

This method is a variation of the yield method and is based on the dividend-paying capacity of the company. The value of a share is determined by capitalizing the expected dividend at the normal rate of return.

Formula:

Value per Share = (Dividend per Share × 100) / Normal Rate of Return

This method is appropriate when dividends are stable and regular. However, it ignores retained earnings and growth potential.

4. Fair Value Method

The Fair Value Method combines both asset-based and earning-based approaches. The value of shares is calculated as the average of the values obtained under the Net Asset Value Method and Yield Method.

Formula:

Fair Value per Share = (Net Asset Value per Share + Yield Value per Share) / 2

This method is widely accepted as it considers both financial strength and earning capacity.

5. Market Price Method

Under this method, the stock exchange quoted price of shares is taken as the value. Generally, the average of the market price over a reasonable period is considered.

This method is applicable only when shares are actively traded on a recognized stock exchange. It reflects investor perception but may be influenced by speculation and market fluctuations.

6. Capitalisation Method

In the Capitalisation Method, the value of the entire business is determined by capitalizing its expected profits at the normal rate of return. The total value is then divided by the number of shares to arrive at the value per share.

Formula:

Capitalised Value = Expected Profit × 100 / Normal Rate of Return

Value per Share = Capitalised Value / Number of Shares

This method is suitable for stable businesses with predictable earnings.

7. Intrinsic Value Method

The Intrinsic Value Method focuses on the true worth of a share based on financial statements, assets, liabilities, and earning potential. It is commonly used by investors for long-term investment decisions.

This method requires careful analysis and judgment, making it more complex but reliable.