In this article we will discuss about the Need and Methods required for Valuation of Shares. Government securities, the price prevailing on the stock exchange may be taken as the proper value. The stock exchange price does not hold good for very large lots. And not all shares are quoted on the stock exchange. Shares of private companies in any case will not be quoted. If, therefore, shares of such a company have to change hands, the value of such shares will have to be ascertained. For the valuation of the assets of a finance or an investment trust company. Where a company is reconstructed under section 494 of the Act and there are dissentient shareholders. 10ths of shareholders in a company agree to transfer shares to another company and the transferee company decides to acquire the shares of dissentient shareholders also. The factors that affect the value of shares of a company are similar to those that affect the value of goodwill of the company.
In fact, valuation of goodwill and valuation of shares are inter-related. Dividend performance — investors are satisfied with a comparatively low yield in case the company declares a uniform dividend from year to year and does not make a default. The normal rate of returns higher when the dividends have been fluctuating. Financial prudence is also a factor. A company which distributes only a part of profits will attract investors without having to offer high yield. Net asset backing is important from the point of view of safety. If tangible assets per share, after deduction of all liabilities, are twice or thrice the paid up value of the share, investors will be satisfied with a lower rate of return than if the net tangible assets are only a little more than the paid up capital. In this case, the net assets of the company are determined and then the figure is divided by the number of shares. Care must be taken to value goodwill. Non- trading assets will also be included.
The assets will be put down at their market value. If there are preference shares, the preference capital will be deducted and only the remainder will be available for the equity shareholders. The figure will then be divided by the number of equity shares and the result will be the intrinsic value of the shares. The following are the balances taken from the balance sheet of John Engineering Ltd. The market value of preference shares will also be calculated in the manner indicated above but the normal rate of return in case of preference shares will be lower than in the case of equity shares because there is priority both as regards dividend and as regards return of capital. If the net assets of the company are not ample to cover the preference capital, investors will expect a higher yield than ordinarily. Investors feel happy if the net assets are about three times the preference capital.
This will increase the value of shares of companies which build up reserves. However, the method of calculating value of shares on the basis of dividends declared will always put a premium on the shares of companies which distribute a larger part of their profits. This is clearly unsatisfactory, since it seems to reward lack of prudence. The method discussed below gives a better picture. Rs 10 each and 20 lakh equity shares of Rs 10 each. All the shares are fully paid up. The average annual profits of the company after providing depreciation but before taxation are Rs 1,80,00,000. It is considered necessary to transfer Rs 34,50,000 to general reserve before declaring any dividend. From the following particulars, calculate the fair value of an equity share assuming that out of the total assets, those amounting to Rs. On march 31, 2012, the balance sheet of Harsh Ltd.
The PE Ratio is really the converse of the normal rate of return applicable to the company. PE Ratio will be 5 i. If the net profit per share or EPS is Rs 7, the price of the share will be, for the PE Ratio of 5, Rs 35. The above is a simple way of stating the point made already except that instead of dividend per share net profit per share is taken. One can see that if either of the two factors, EPS or PE ratio changes, the price of the share will change. In the example given above, if the PE ratio becomes 4 i. The PE Ratio is high where risk is low and low when risk is high, say, when in the capital employed loans preponderate. Often, the dividend declared by a company is much less than the rate of its earning. Since accumulated profits are likely to be distributed sooner or later, in the form of bonus shares, usually the market price is likely to be based on the earnings of the company rather than the dividend. This provides a firm basis for valuation of shares, since this relates the value to the real efficiency, as measured by profitability of the company.