UNIT I: SHARES AND THEIR VALUATION

SECURITY ANALYSIS & PORTFOLIO MANAGEMENT

WHAT IS GOODWILL?
Goodwill is the value of the reputation of the firm which the business builds up due to its efficient service to its customers and quality of its products. http://educ.jmu.edu/~drakepp/FIN362/resources/industry.pdf

VALUATION OF SHARES
a share represents an interest in a company. There are a number of ways in which the shares of a company may be valued. It can be valued either as an entitlement to a share of future profits, or as an interest in the net assets that comprise the company.

FACTORS AFFECTING VALUATION OF SHARES:

The nature of the companys business. Percentage of dividend declared on the shares. The demand and supply of shares. The income yielding capacity of the company. The availability of sufficient assets over liabilities. General economic condition.

Financial, political and others factors affecting the business.

METHODS OF VALUATION

Assets Backing Method:This method is also known as assets valuation method or intrinsic value method. Under this method the share value is

simply the net assets or equity divided by the number of

shares.

THE FOLLOWING POINTS ARE IMPORTANT AND SHOULD BE BORNE IN MIND FOR ESTIMATING THE NET ASSETS:
The fixed assets of the company should be revalued at their net realizable value. Inventory should also be taken at current market prices. Investments should be taken at current market prices. These can be taken at cost if the fall in the market value is believed to be temporary. Other current assets like bills payable or sundry debtors should be could be valued at their expected net realizable value. All fictitious assets appearing in the Balance sheet are to be eliminated. Goodwill may be valued on the basis of super profits. All unrecorded assets and liabilities are to be taken into consideration. all external liabilities are to be deducted to arrive at the net assets figure.

THE ASSETS BACKING METHODS IS GENERALLY APPLIED UNDER THE FOLLOWING CIRCUMSTANCES:

For formulating scheme of amalgamation For acquiring majority of the shares and controlling the company When there is liquidation.

YIELD VALUE METHOD

This method is also known as Market value method. The world yield means a rate of return relating cash

invested to cash receive.

EARNING YIELD:
A company cannot grow and can be in a position to increase its dividends, if it distributes all of its profits as dividend. There are also legal restrictions by the companies act for distribution of profits as dividends. Therefore a shareholder will have interest both in the retained profits as well as distributed profits.
Value per Share=
Expected Rate of Earnings(ERE) Normal Rate of Return (NRR)

Face Value of Share

Expected Rate of Earnings (ERE) =

Profit after Tax Paid up value of shares

100

DIVIDEND YIELD
there may circumstances where the shareholder has little or no influence over dividend policy. In such cases it may be more appropriate to value the shares based on dividends than earnings.

Value per Share=

() ()

THE FOLLOWING MATTERS MUST BE TAKEN INTO CONSIDERATION WHILE MAKING AN ESTIMATE OF THE EXPECTED FUTURE PROFITS AVAILABLE FOR EQUITY SHARE DIVIDENDS:-

The average past profits of the company require an adjustment, if

necessary, should any special factor cause the future profits to differ
from the past. Adequate provision should be made for depreciation taxation and other liabilities. The amount of profits to be set aside for preference share dividend.

DIVIDEND DISCOUNT MODEL

the value of an equity share is equal to the present value of dividends expected from its ownership plus the present value of the sale price expected when the equity share is sold.

Assumption:1. Dividends are paid annually. 2. The first dividend is received one year after the equity share is bought.

SINGLE-PERIOD VALUATION MODEL

Let us begin with the case where the investor expects to hold the equity share for one year. The price of the equity share will be:

P0=
Where, P0 = current price of the equity share; D1 = dividend expected a year hence;

1 (1+)

1 (1+)

P1 = price of the share expected a year hence

r = Rate of return required on the equity share

Ex.1 Prestiges equity share is expected to provide a dividend

of Rs. 2.00 and fetch a price of Rs. 18.00 a year hence. What

price would it sell for now if the investors required rate of

return is 12 per cent?
Ans: - Rs. 17.86

WHEN EXPECTED GROWTH RATE INCLUDED

What happens if the price of the equity share is expected to grow at a rate of g per cent annually? If the current price, P0, becomes P0 (1 + g) a year hence,

 Example2. The expected dividend per share on the equity share of Road
king Limited is Rs. 2.00. The dividend per share of Road king Limited has grown over the past five years at the rate of 5 per cent per year. This growth rate will continue in future. Further, the market price of the equity share of Road king Limited, too, is expected to grow at the same rate. What is a fair estimate of the intrinsic value of the equity share of Road king Limited if the required rate is 15 per cent? Ans:- Rs. 20.00

EXPECTED RATE OF RETURN: What rate of return can the investor expect, given the current market price and forecast values of dividend and share price? The expected rate of return is equal to:

R = D1/P0 + g

 Example.3 .The expected dividend per share of Vaibhav Limited is Rs. 5.00. The dividend is expected to grow at the rate of 6 per cent per year. If the price per share now is Rs. 50.00, what is the expected rate of return? Ans:- Rs.16

MULTI-PERIOD VALUATION MODEL

Having learnt the basics of equity share valuation in a single-period framework, we now discuss the more realistic, and also the more complex, case of multiperiod valuation. Since equity shares have no maturity period, they may be expected to bring a dividend stream of infinite duration. Hence the value of an equity share may be put as:

Where D1,D2, Dn= Annual dividends to be received each year.

Pn= Sale Price At the end of the holding price.

r= required rate of return n=Holding period in years

 Example.3 .if an investor expected to get Rs.3.50,Rs.4 and Rs.4.50 as dividend from a share during the next three years and hopes to sell it off at Rs.75 at the end of the year and if his required rate of

return is 25% what will be the present value of this share to the
investor.

Ans:Rs.46.06

ZERO GROWTH MODEL

If we assume that the dividend per share remains constant year after

year at a value of D, Eq. (b) becomes

 A firm pays a dividend of 20% on the equity shares of face value of Rs.100 each. Find out the value of the equity share given that the dividend rate is expected to remain same and the required rate of return of the investor is 15% Ans: 133.33

CONSTANT GROWTH MODEL: One of the most popular dividend discount models assumes that the dividend per share grows at a constant rate (g). The value of a share, under this assumption, is:

 Example. Ramesh Engineering Limited is expected to grow at the rate of 6 per cent per annum. The dividend expected on Rameshs equity share a year hence is Rs. 2.00. What price will you put on it if your required rate of return for this share is 14 per cent? Ans: Rs.25

MULTI STAGE MODEL

The constant growth assumption may not be realistic in many situation. The growth in dividends may be at varying rates. A typical situation for many companies may be that a period of extraordinary growth will prevail for a certain number of years after which growth will change to a level at which it is expect to continue indefinitely. represented by a two state growth model. In this model the future time period is viewed as divisible into two different growth segments the initial extraordinary growth period and the subsequent constant growth period. This situation can be

MULTI STAGE MODEL

A company paid a dividend of Rs.1.75 per share during the current year . It is expetedt to pay a dividend of Rs.2 per share during the next year. Investor

forecast a dividend of Rs.3 and Rs.3.50 per share respectively during the two subsequent years. After that it is expected the annual dividends will grow at 10 per cent per year into an indefinite future. If the investor required rate of return is

20% .

Price Earnings Based valuation:Definition

The price to earnings ratio (P/E ratio) is the ratio of market price per share to earnings per share.

It is also sometimes known as earnings multiple multiple or price

CALCULATION (FORMULA)
Price to Earnings Ratio =

Earnings per Share

Price to Earnings Ratio = Earnings after Taxes and Preference Dividends

Price Earnings Based valuation: The average P/E ratio is normally from 12 to 15 however it depends on market and economic conditions. P/E ratio may also vary among different industries and companies. P/E ratio indicates what amount an investor is paying against every rupees of earnings.

Sr

Company

Last Price

Change

% Chg

CEPS *

EPS *

Tata Elxsi

507.75

2.65

0.52

26.61

19.00

TCS

2,189.80

11.60

0.53

89.34

85.24

Oracle Fin Serv

3,096.50

21.80

0.71

141.90

134.94

4 5 6

Infosys Wipro HCL Tech

3,780.80 586.45 1,546.85

30.05 8.35 15.95

0.80 1.44 1.04

184.11 29.01 75.95

167.46 26.17 69.63

Acropetal Tech

4.85

0.07

1.46

3.99

0.25

Persistent

1,141.35

20.45

1.82

75.54

60.62

Sr

Company

Last Price

Chan % Chg ge 2.65 0.52

CEPS *

EPS *

P/C

P/E

Tata Elxsi

507.75

26.61

19.00

19.08

26.72

TCS

2,189.80

11.60

0.53

89.34

85.24

24.51

25.69

Oracle Fin Serv

3,096.50

21.80

0.71

141.90

134.94

21.82

22.95

4 5 6

Infosys Wipro HCL Tech

3,780.80 586.45 1,546.85

30.05 8.35 15.95

0.80 1.44 1.04

184.11 29.01 75.95

167.46 26.17 69.63

20.54 20.22 20.37

22.58 22.41 22.22

Acropetal Tech

4.85

0.07

1.46

3.99

0.25

1.22

19.40

Persistent

1,141.35

20.45

1.82

75.54

60.62

15.11

18.83

Sr 1 2 3

Company IOB SBI IDBI Bank

Last Price 45.35 1,505.50 55.80

Change -1.15 -5.25 -0.40

% Chg -2.47 -0.35 -0.71

CEPS * 4.50 164.61 7.99

EPS * 3.40 149.34 7.22

State Bk Mysore PNB

Bank of Baroda

391.95

4.15

1.07

60.54

50.74

535.00

-4.45

-0.82

110.08

101.28

530.40

3.40

0.65

109.44

102.46

7
8

Dena Bank
Andhra Bank

51.85
54.50

0.15
-0.75

0.29
-1.36

11.34
13.16

10.46
11.74

Sr 1 2

Company IOB SBI

Last Price 45.35 1,505.50

Change -1.15 -5.25

% Chg -2.47 -0.35

CEPS * 4.50 164.61

EPS * 3.40 149.34

P/C 10.08 9.15

P/E 13.34 10.08

IDBI Bank

55.80

-0.40

-0.71

7.99

7.22

6.98

7.73

State Bk Mysore

391.95

4.15

1.07

60.54

50.74

6.47

7.72

PNB

535.00

-4.45

-0.82

110.08

101.28

4.86

5.28

Bank of Baroda

530.40

3.40

0.65

109.44

102.46

4.85

5.18

Dena Bank

51.85

0.15

0.29

11.34

10.46

4.57

4.96

Andhra Bank

54.50

-0.75

-1.36

13.16

11.74

4.14

4.64

Sr

Company

Last Price

Change

% Chg

CEPS *

EPS *

Maruti Suzuki

1,682.00

-1.40

-0.08

168.29

106.68

M&M

942.85

-0.05

-0.01

72.44

60.90

Sr.no

Company Yuranus Infra GMR Infra Siemens ABB Punj Lloyd BEML Thermax

Last Price

Change

% Chg

CEPS *

EPS *

P/C

P/E

10.29

0.20

1.98

0.01

0.01

1,029.00

1,029.00

2 3 4 5 6 7

19.95 588.00 677.00 25.90 205.60 682.00

-0.35 -2.35 -2.35 -0.40 -2.55 5.75

-1.72 -0.40 -0.35 -1.52 -1.23 0.85

0.09 12.51 13.35 7.24 18.34 26.62

0.07 5.49 8.47 0.38 6.28 22.02

221.67 47.00 50.71 3.58 11.21 25.62

285.00 107.10 79.93 68.16 32.74 30.97

Titagarh Wagons

93.90

-1.50

-1.57

6.71

3.33

13.99

28.20

Texmaco Rail

39.40

-0.10

-0.25

2.13

1.61

18.50

24.47

Sr

Compan Last y Price

Change % Chg

CEPS *

EPS *

P/C

P/E

Maruti Suzuki

1,682.00

-1.40

-0.08

168.29

106.68

9.99

15.77

M&M

942.85

-0.05

-0.01

72.44

60.90

13.02

15.48