NAV

NAV

1. Need for Valuation of Shares

When Valuation is Necessary:

• Stock Exchange Quotes: For shares listed on the stock exchange, their market price can be used. However, this may not apply in certain situations such as:
  • Large Transactions: Prices may differ for very large lots.
  • Private Companies: Shares not listed on the exchange need separate valuation.

Circumstances for Valuation:

• Amalgamation Schemes: When companies merge, shares need to be valued to determine exchange ratios.
• Controlling Shares Transactions: For buying or selling a significant stake, valuation helps in determining the fair price.
• Finance/Investment Trusts: Valuation of shares helps in assessing the assets of these entities.
• Security for Loans: Shares might be used as collateral; their value needs to be determined.
• Company Reconstruction: In case of company restructuring, dissenting shareholders' shares must be valued.
• Acquisitions: When a company acquires shares from dissenting shareholders, valuation is required.

2. Factors Affecting Share Value

• Restrictions on Transfer: Shares with restrictions (like lock-in periods) are riskier, leading to higher expected returns.
• Disabilities of Shares: Partly paid shares might offer higher returns compared to fully paid shares due to higher risk.
• Dividend Performance: Consistent dividends lead to lower required returns, while fluctuating dividends necessitate higher returns.
• Financial Prudence: Companies that retain profits (instead of distributing them) might offer lower returns due to their prudent financial management.
• Net Asset Backing: If the company’s tangible assets significantly exceed the paid-up value of shares, investors might accept lower returns due to increased safety.

3. Valuation Methods

a. Net Asset Method (Intrinsic Value or Asset Backing Method)

• Concept: Focuses on the company's net assets to determine share value.
• Steps to Compute:
  • Goodwill Value: Determine the value of goodwill, which represents the intangible value of the company.
  • Fixed Assets: Assess fixed assets at their realizable (sale) value, not just book value.
  • Floating Assets: Evaluate current assets (like inventories and receivables) at market value.
  • Exclude Fictitious Assets: Ignore non-realizable assets like preliminary expenses and accumulated losses.
  • External Liabilities: Deduct all liabilities, including contingent liabilities.
• Formula:
  • Net Assets = Total Realizable Value of Assets - Total External Liabilities
  • Total Value of Equity Shares = Net Assets - Preference Share Capital
  • Value of One Equity Share = (Net Assets - Preference Share Capital) / Number of Equity Shares

b. Yield Method

• Concept: Values shares based on the income or return they generate.
• Formula:
  • Value of Shares = Paid-Up Value × (Expected Rate of Return / Normal Rate of Return)
• Example: If a share has a paid-up value of Rs. 10, the expected return is 9%, and the normal rate of return is 6%, the value of the share would be:
  • Value of Shares = Rs. 10 × (9% / 6%) = Rs. 15
• Explanation: This method determines the value by comparing expected returns with the typical returns required by investors.

c. Value of Right Shares

• Concept: Determines the value of the right to purchase new shares at a preferential price.
• Formula:
  • Value of Right = (Market Value of Existing Shares - Issue Price) × (Number of Right Shares / Total Holdings)
• Explanation: The formula calculates the benefit of acquiring new shares at a discounted price relative to the market value of existing shares.

d. Earning Capacity Method

• Concept: Assesses shares based on the company's earnings relative to its capital.
• Formula:
  • Rate of Earning = (Profit Earned / Capital Employed) × 100
• Explanation: This method calculates the rate of return based on the company's net profit after adjusting for reserves and taxes. It helps to gauge the profitability and efficiency of the company's capital use.

e. Fair Value Method

• Concept: Averages the intrinsic value and yield value to provide a balanced valuation.
• Formula:
  • Fair Value = (Intrinsic Value + Yield Value) / 2
• Explanation: This method combines different valuation approaches to offer a more comprehensive estimate of share value.

Summary:

• Net Asset Method emphasizes the company's tangible assets and liabilities to determine share value.
• Yield Method focuses on the returns or income from shares, comparing expected returns with normal rates.
• Value of Right Shares calculates the benefit of purchasing new shares at a discounted price.
• Earning Capacity Method evaluates shares based on the company's profitability relative to its capital.
• Fair Value Method averages the intrinsic and yield values to provide a balanced estimate.

Each method offers a unique perspective, making them suitable for different scenarios and valuation needs.