Equity valuations Flashcards
(6 cards)
Ways of valuing equity
o Market value
o Dividend discounted model
o Net asset value per share ( NAV per share )
o Value added measures
o Measurable key factors
Equity val by market value
o This is always the starting point for valuation of individual equity if a suitable market
exists
o For most shares, this is objective and simple means of valuation
Equity val by discounted discount model (assumptions and issues with model)
o Normally used in the following cases
βͺ Valuing unlisted shares
βͺ Check whether market value is reasonable or under- or over-priced
o Derives the share price as the discounted value of the estimated future dividend
stream
o Value of share = π·/
πβπ =
π·0(1+π)/
πβπ
o π·π is the most recent dividend received and D is the dividend to be paid in one year
from now
o Assumptions of the model : (6)
βͺ Dividends are payable annually , with the next payment in one yearβs time
βͺ The dividends grow at a constant rate , g, per annum
βͺ The required rate of return is ,π, and independent of the time in which
payment Is made
βͺ π > π and defined consistently β either include inflation or net inflation
βͺ dividend proceeds can be reinvested at I per annum
βͺ no taxes and expenses
o issues with using the dividend discount model (7)
βͺ we do not know the value of interest (i) to use in the model
* assumption of constant required rate of return may not appropriate
β yield curve steeply going up or down over year
* interest rate used will normally be yield on long term government
bond plus appropriate addition for the riskiness of equity
βͺ we do not know the growth rate of dividends which should be used
* this value reflects future expectations of future dividends β reflected
by the expectations of future profitability of company
* constant dividend growth must seem as unrealistic assumption
βͺ results obtained are sensitive to the assumed level of (π β π)
βͺ equation given ignores tax
* tax paying investors should use net dividends received and suitable after tax rate of return
βͺ assumes annual dividends even though they could be paid on half yearly
basis
βͺ model is of no use unless π > π
βͺ the model also ignores the expenses
Equity eval by NAV per share
o can be adopted for companies with significant tangible assets ( not good for
companies with significant intangible assets)
o similar approach can be adopted for property investment company β property
company and investment unit trusts where underlying assets may have valuations in
their own right
o this represents what the investors would receive less expenses if the investment
trust was wound up
Equity val by value added measures
o shareholderβs value is an attempt to get an intrinsic or underlying value of an
investment rather than its accounting value
o economic value added looks at one yearβs results and deducts the cost of servicing
the capital that supports these results
βͺ if the EVA is positive , then the companyβs activities over the year have
added value or created value for the shareholders
βͺ EVA acts a bridge between quoted share value and accounting values to
give a framework for executive compensation schemes
Other equity valuation methods
o Appropriate where companies are not making profits and a net asset valuation is not
appropriate
o Other methods need to be employed as the methods above imply one of the
following
βͺ Company declares dividends
βͺ Company is making profit β which model assumes this???
βͺ Net asset value is suitable
o Not always the case when the company is
βͺ Young β and yet to declare any dividends
βͺ Making losses
βͺ Few tangible assets
o Other methods used often involve a relevant and measurable key factor for the
companyβs business
o The relationship between the factor and the market price of other quoted
companies is then used as basis for valuation
βͺ The factor used will depend on
* Business of the company
* Information that is available β quantitative/ qualitative
* The business aims and objectives
