Stock Valuation

4.Add the values calculated in step 1 and 3, which is the value of the share.

The above-mentioned steps can be more precisely understood through the use of this example.

Example

A firm pays $3 dividend per share in the currently, which is expected to grow at 10% for the next three years after which growth rate will decrease to 5% forever. Assuming 15% required rate of return compute the value of the share.[sky]

Solution

Step 1

Present value of dividends for first three years.

Step 2

Dividend expected in year 4 after the growth of 5% = $4.2

Price at the end of year 3 = P = $4.2 / 0.15 – 0.05 = $42

Step 3

Present Value = P3 x PVIF 15%, 3 = $42 x 0.658 = $27.64

Step 4

Value of the share = P = $8.25 + $27.64 = $35.89

Other Approaches to The Valuation of Shares

In addition to above there are other valuation techniques for common shares. These approaches are:

• Book value approach
• Liquidation value
• Price / Earning multiples

Book Value Approach

Under book value approach the value of the share is book worth divided by number of equity shares. Book worth is the equity capital plus reserves and surpluses. The above statement can be described, as that book value per share is the amount per share on the sale of the assets of the firm at their exact book value minus all liabilities including preference shares.

Liquidation Value

Liquidation value per share is based on the concept that if all assets are sold, liabilities including preference shares are paid, and any remaining amount is divided among common stock holders.

P/E Ratio

This is a technique to compute value of the shares multiplying expected return per share by the average price / earning ratio for the industry.