Discuss various methods of valuation of shares? Explain.

Methods of Valuation of Shares

Valuation of shares is the process of determining the fair value of a company's shares, which is essential for investors, shareholders, and company management. Several methods are used to value shares, each with its own approach and assumptions. Some common methods include:

1. Net Asset Value (NAV) Method:

• The NAV method calculates the value of a company's shares based on its net assets, which is the difference between total assets and total liabilities. The NAV per share is calculated by dividing the net assets by the number of outstanding shares. This method is suitable for companies with substantial tangible assets.

2. Earnings Capitalization Method:

• The earnings capitalization method values shares based on the company's expected future earnings. The value of the shares is calculated by dividing the expected earnings per share (EPS) by the capitalization rate (the rate of return required by investors). This method is suitable for companies with stable earnings and predictable growth.

3. Price-Earnings (P/E) Ratio Method:

• The P/E ratio method values shares based on the company's price-to-earnings ratio, which is calculated by dividing the market price per share by the earnings per share. The value of the shares is calculated by multiplying the average P/E ratio of comparable companies by the company's earnings per share. This method is suitable for companies with established earnings and a stable market.

4. Dividend Discount Model (DDM):

• The DDM values shares based on the present value of future dividends. The value of the shares is calculated by discounting the expected dividends at the company's cost of equity. This method is suitable for companies that pay regular dividends and have a stable dividend policy.

5. Comparable Company Analysis (CCA):

• CCA values shares based on the market multiples of comparable companies. The value of the shares is calculated by multiplying the financial metrics (such as earnings, sales, or book value) of comparable companies by the corresponding multiples and applying them to the company being valued. This method is suitable for companies with comparable peers in the same industry.

Conclusion:

• Valuation of shares is a complex process that requires consideration of various factors and methods. Each method has its own strengths and weaknesses, and the choice of method depends on the nature of the company and the purpose of the valuation. By using a combination of methods, investors and analysts can arrive at a more accurate and reliable valuation of shares.