Different Methods for Valuing Shares and Assets

Investors attempt to determine the genuine worth of a company’s stock before putting their money into it. Valuation of shares and assets describes the method used to find the worth of a company. It’s easy to find out how much a share of a publicly owned company is worth. A corporation’s stock price will rise due to strong demand for its shares. However, this is not reflective of the fair value of the share. 

Valuing shares for privately held companies is essential and challenging. It demands comprehensive knowledge and the challenges in share valuation. That is why this article has compiled the common methods for valuing shares and assets. 

Let’s explore everything related to share valuation methodologies here.

Share valuation and its methods 

Share valuation becomes simpler by listing them on a stock market, allowing buyers and sellers to determine their value easily. The stock market quotes don’t always reflect the real value of the shares; thus, a professional valuer must use fair and solid criteria to determine the share’s worth. 

But how do we assess their value? Let’s find out.

What is Share Valuation and How Does It Work?

Share Valuation is a method used to estimate the economic worth of an asset, capital, or business. It entails determining something’s value in monetary terms and presenting a numerical depiction of that worth. In many areas of decision-making, such as investments, M&A, financial reporting, and strategic planning, valuation is an essential tool. The importance of valuation comes from its capacity to provide information and understanding of an asset’s finances and possible risks and rewards.

Process of Share Valuation

The share valuation process involves applying quantitative methods to ascertain the true value of a company’s shares. Analysts examine a company’s financial data, and projected cash flows, to verify its present worth. Before investing in a firm, they determine if its shares have undergone overvaluation or undervaluation by determining their worth.

Overvaluation occurs when the market value of a share exceeds its inherent worth. When the market price of a share falls short of its intrinsic worth, however, we say that the share has undergone undervaluation. 

Benefits of share valuation

Share valuation offers many advantages, from helping with compliance and strategic planning to directing investment decisions. 

Let’s discuss them one by one.

• Informed Investment Decisions- By comparing a stock’s intrinsic worth to its market price, share valuation aids investors in making educated judgments. Insights like this help investors choose between overpriced and undervalued companies.
• Strategic Planning for Companies- Share value helps businesses plan strategically by assessing the financial effects of various company decisions. It is useful for achieving growth goals by directing resources in the right direction.
• Risk Management- The value of a company’s shares might reveal where a portfolio could be vulnerable. Assuring that investment selections align with risk tolerance and financial objectives permits modifications to limit risk.
• Facilitating Mergers and Acquisitions- Valuation techniques are essential to arrive at a reasonable share exchange ratio in mergers. That way, neither company will be under or overvalued, and the share valuation will be fair to all parties involved.
• Financial Reporting Compliance- Businesses must include the assets’ fair market value when preparing financial statements. Ensuring compliance with accounting standards is crucial for providing stakeholders with accurate and transparent financial statements; share value is one way to do this.

Challenges and Considerations

Recognizing the true worth of assets and shares is not only a prudent financial move but also a strategic requirement. 

Let’s discuss the challenges of share valuation here.

• Data Accuracy – Using high-quality and trustworthy data in the study is crucial for accurate appraisal. A lack of thorough or correct data can cause inaccurate estimates, affecting decision-making.
• Subjectivity in Valuation – Interpretations of comparable company metrics, future cash flows, and growth rates can frequently introduce a level of subjectivity into share valuation methods. This subjective nature provides an element of bias that might affect the outcomes.
• Regulatory and Legal Aspects – The regulatory and legal factors affecting share valuation methods differ from jurisdiction to the next. The credibility and acceptability of the appraisal depend on your adherence to these guidelines.

Common Methods for Valuing Shares and Assets

Asset and Share Valuation influences investment choices, long-term plans, and business deals. The following section looks into several approaches used to determine share value to give investors and financial experts a detailed grasp of the complexities involved.

Market Valuation

Market valuation relies on the principle of supply and demand in the open market. This metric captures the market value of an asset or share, considering factors including investor sentiment, economic climate, and market sentiment. 

Market Capitalization = Current Market Price per Share × Total Outstanding Shares

Example: Let’s say that the stock price of a Company is $50/share right now. Assuming one million shares are in circulation, the firm’s market capitalization would be $50 million, computed by multiplying the current market price ($50) by the total number of outstanding shares.

Intrinsic Valuation

The purpose of intrinsic share valuation is to ascertain the actual value of an item by looking at its basic qualities. This strategy frequently involves examining financial documents, growth forecasts, and economic indicators for an objective assessment.

Intrinsic Value=EPS×(1+r)×P/E Ratio

Where:

• EPS  is the earnings per share,
• r is the expected growth rate, and
• P/E Ratio is the price-to-earnings ratio.

Example: Suppose a company has an EPS of $3, an expected growth rate of 6%, and an industry-average P/E ratio of 15.

Intrinsic Value=$3×(1+0.06)×15

In this example, the intrinsic value of the stock, based on the given formula, would be $47.70 per share. According to the expected growth rate and industry P/E ratio, the stocks might go through undervaluation if the current market price is below $47.70 or overvalued if it’s above this intrinsic value.

Comparable Company Analysis (CCA)

Comparable Company Analysis (CCA) compares a target company’s financial metrics to other firms in the same sector. This approach operates under the assumption that identically valued companies should be comparable.

Comparable Company Valuation = Comparable Company Metric (e.g., P/E ratio) × Target Company Metric (e.g., Earnings per Share)

Example: Consider two companies in the same industry: A and B. With A having $3 in profits per share and B trading at a P/E ratio of 15, the indicated valuation using CCA would be $45 per share.

Discounted Cash Flow (DCF)

DCF analysis estimates the present value of future cash flows generated by an investment. It considers the time value of money, discounting future cash flows to their current value.

DCF= CF1/(1+r)¹ + CF2/(1+r)² + ………. CFn/(1+r)ⁿ

CF represents cash flows for each period, and 

r is the discount rate. 

Example: If a project generates cash flows of $1 million annually for the next 5 years with a discount rate of 10%, the DCF would be approximately $4.11 million.

Factors Influencing Valuation

Several variables influence the perceived value of shares and assets in the complex field of Share valuation. 

Let’s look into three critical components—financial metrics, industry dynamics, and market conditions—significantly impacting the valuation process.

Financial Metrics	Earnings from a business's primary activities make up its revenue. An increase in a company's value is common when its revenue grows rapidly and steadily. Income represents a business's profits, expressed as a ratio of them to the number of shares outstanding (EPS). One of the most basic ways investors measure a company's profitability is by looking at its profits. An organization's book value is its net asset value, resulting from deducting its entire liabilities from its total assets. The book value of a firm is an important indicator of its true value.
Industry Dynamics	Investors often assign greater value to industries they believe have a strong chance of seeing future growth in sales and profitability. The rivalry in a given market can affect profit margins and, by extension, the value of businesses that operate there. An organization's book value is its net asset value, resulting from deducting its entire liabilities from its total assets. The book value of a firm is an important indicator of its true value.
Market Conditions	Fundamental economic concepts such as supply and demand are crucial. The price could increase when there is a lot of interest in a stock but insufficient supply. The state of the economy affects values via its effects on consumer spending, business profits, and interest rates. Market perception and emotions can cause valuation swings. Valuations tend to rise when sentiment is positive and fall when sentiment is negative.

• on consumer spending, business profits, and interest rates.
• Market perception and emotions can cause valuation swings. Valuations tend to rise when sentiment is positive and fall when sentiment is negative.

How can one select the most suitable method for evaluating stocks?

Valuation methods cannot be chosen based on a universal rule, as every company has distinct qualities and strengths. The valuation method selected depends on the industry, the information available, and the company itself. 

For instance, sectors like FMCG have predictable cash flows, and a discounted cash flow method may be suitable. Market multiples, such as the price-to-earnings (P/E) ratio, are more appropriate for banks or insurance companies due to their unpredictable cash flows. Dividend-paying companies are better suited for the dividend discount model. 

It is, therefore, crucial to carefully consider the right valuation method for each company.

Need help with your share valuation? 

Gaining share valuation experience is crucial for entrepreneurs and long-term investors to enhance their proficiency and achievements. Potentially successful long-term investors may use strategies to evaluate and pursue opportunities. Depending on your goals and requirements, staying abreast of the best share valuation methods is critical. 

By providing a complete platform that caters to the varying demands of stakeholders, Eqvista’s state-of-the-art tools and technology simplify the share valuation process. Eqvista helps customers maintain cap tables and accurately value equity, allowing them to make better decisions, understand financial intricacies, and plan for long-term growth. 

Once you see that we match your needs, you may check our freemium packages before upgrading to the premium features. Book a quick consultation call with us to get started!