Valuation of Equities

Dividend Capitalisation Approach:

The intrinsic value (P0) of the stock paying a dividend 'D' and the expected price of 'P1' and the required rate of return 'Rr' is given by P0 = (D+ P1)/(1+Rr)

Therefore from the above formula, we can derive the required rate of return (Rr) as
Rr = (D/P0) + g

where (D/P0) is called as Dividend Yield.

The expected price 'P0' of the equity share which has a price growth of 'g' and the required rate of return 'Rr' is given by P0 = D/(Rr-g)

Example 1:

The dividend per share of ABC Ltd. is Rs.5.00. It is expected to grow at a rate of 4% per year. What is the expected rate of return for the investor when the current market rate of the share is Rs.50

Rr = (5/50) + 4%

i.e. 10% + 4% = 14%

In case of companies having the Earnings as the only source of income, then the required rate of return is given by

Intrinsic Value = (Earning per share * Dividend payout ratio) * 100

(Discount rate - Growth rate)

Example 2:

What is the intrinsic value per share of scrip XYZ Ltd. given the following ?

Earning per share = Rs.3.00
Dividend payout ratio = 0.6
Discount rate = 15%
Growth rate = 6%

Solution:

Intrinsic Value = (Earning per share * Dividend payout ratio) * 100
(Discount rate - Growth rate)
= (3.00 * 0.6)*100 / (15 - 6) = Rs.20

Earning per share & Price-earnings Approach

The other approach used in financial analysis is the Price-Earnings (P/E) ratio approach, the value as per the P/E approach is given by

Value = Earning per share (EPS) * Price Earnings ratio

where EPS = (profit after Tax / no. of equity shares outstanding)
P/E = (Market Price of the share / EPS)

Example:

What is the Price-Earnings ratio of the company if the Profit after tax is Rs.100 crore. The current market rate of the share is Rs.250 /-

EPS = (PAT - Preference Dividend)/ Issue capital
= (Rs.100 Cr. - Rs.10 Cr.)/ 90 lakh shares
= 100

Therefore, P/E = Market Price/EPS
= Rs.250 / 100
= 2.5

Book Value Approach:
Book value per share of a company is

Book Value = (net worth of the company / no. of shares outstanding)

where net worth includes equity capital of the company, reserves and surplus. The intrinsic value thus arrived may vary due to the accounting policy followed by the company.

Example:

What is the book value of the firm having a net worth of Rs.2500 crore and the number of shares outstanding is 50 crore?
Intrinsic Book Value = Rs.2500 crore / 50 crore
= Rs.50

Liquidation Value of the Share Approach :

The value of the shares on liquidation of the company is the company is calculated after deducting the amount to be paid to the creditors & the preference shareholders.

Thus the value of the share is given by
Value = (Liquidation value of the company - Amount paid to be the creditors
& preference shareholders) / no. of equity shares outstanding.

Example:

The company XYZ LTD. is liquidated realizing Rs.10 crore from liquidation of it assets. The company had to pay Rs.1 crore to the creditors. What is the value of the shares, if the total outstanding number of share is 45 lakh.
Value of each share = (Rs.10 crore - Rs.1 crore)/ 45 lakh share
= Rs.20