Valuation of shares is a complicated process in which different complex quantitative techniques and specialized approaches are followed. The value of the share usually will vary as it will largely depend on the demand and supply of the market.
You can easily know about the price of a share of any listed company that is traded publicly but with respect to private companies the shares may not be publicly traded, and in this situations, the valuation of shares is really challenging but is crucial. It requires a lot of experience and expertise to come up with the right value of the share that will determine the company’s worth.
When is share valued
There are specific times when you will need to know the value of a share. Listed below are a few such instances:
- One of the important reasons to value a share is when you want to sell your business and get the right price of it
- When you approach a bank for a loan on your company’s worth as the bank will provide it based on your shares that it will keep as a security
- At the times of any merger, acquisition, amalgamation, reconstruction, retirement and other specific requirements
- When you want to convert the shares of your company from preference to equity
- When you want to implement an Employee Stock Ownership Plan or ESOP
- For any tax assessments under the gift tax and wealth tax acts
- In case of any company litigation where the value of shares is required legally
- When an investment company holds shares and
- To compensate the shareholders or
- The company is nationalized.
Sometimes, it is required to evaluate even the publicly traded shares because the market quotation may not reveal the true picture. It may also be necessary when a large number of shares are transferred.
The different approaches
There are different approaches followed for valuation for transfer of shares, and there are a few specific reasons to choose a particular method for share valuation. However, the method to follow will usually depend on the purpose of such valuation. Sometime a combination of methods may be used for evaluation purpose for your shares to get a more accurate and reliable value. The different approaches to follow and its specific reasons are as follows:
- Assets Approach – This is the method followed for those companies that are essentially capital-intensive. It may have invested a large number of its capital assets or may have a large volume of its capital as work in progress. This method will ensure proper value when it is used for valuing the shares during absorption, amalgamation or liquidation of companies.
- Income Approach – This approach has two distinct methods namely Price Earning Capacity or PEC method and the Discounted Cash Flow or DCF method. In the DCF method, the projection of cash flows in the future is used to determine the fair value provided the data is available. On the other hand, the PEC method is used to evaluate historical earnings and also if any entity is not in the business for a long time or may have just started its operation.
- Market Approach – In this method, it is the market value of the shares of the company is considered for evaluation purpose. However, this method is only feasible for the listed companies as their share prices can be easily obtained from the open market. Moreover, if there are any set of peer companies that are engaged in similar business and are listed, then this method can be also be used to determine the public share prices of the company.
There is another method followed for valuation for the acquisition of a company based on shares. This is the Yield method that has two distinct methods followed during the evaluation process. Ideally, the yield is the expected rate of return on investments made by the company. The two types are explained below:
Earning Yield – In this method, the shares of the company are valued on the basis of the expected earnings. The normal rate of return is considered in this method. There is a specific formula used to value each share. The market-based approach is deducted from the earnings yield to determine the value of each share of the company.
Dividend Yield – This is a specific method in which the shares are valued on the basis of the expected dividend it will earn considering the normal rate of return on its investments. Once again a specific formula is used for this calculation which is:
The expected rate of dividend = (profit available for dividend/paid up equity share capital) X 100.
Unique nature of the asset-based approach
Ideally, no one valuation method will fit a specific purpose, and therefore there are so many different approaches designed. However, the method to use will depend on the availability of the data, the nature of the business and the volume of the company and its shares.
The features of the asset-based approach are as under:
- The intangible assets and contingent liabilities are considered in this approach
- It is useful for manufacturers and distributors
- It is useful where there is a large volume of capital assets
- It is used as a reasonableness check of the conclusions that are derived from income or market approaches
In this method, the net value of the assets of the company is divided by the number of shares which gives the actual value of each share.
Few points to consider in this specific approach which is commonly followed are:
- All assets must include all current assets and liabilities such as accounts receivables and payables along with any other provisions.
- Fixed assets are to be considered at the realizable value.
- Valuation of goodwill must be done and included as a part of the intangible assets of the company
- All unrecorded assets and liabilities must be considered as well.
Apart from that, all fictitious assets such as preliminary expenses, accumulated losses, discounts on the issue of shares and debentures and others must be eliminated during calculation.
Seema Mehra is a Chartered Accountant at Ashok Maheshwary & Associates, tax firms in india that provide statutory audit in a convenient manner. She is a professional writer and loves to share Financial related topics.