Share Pricing

What are Shares?Types of Shares – Ordinary Shares:- Give the Ownership of

the business and Voting rights.

- Dividends are paid at company’s discretion

Preference Shares:- Does not carry voting

rights. - Pre-determined rate of

return and given priority in dividend payments Script/ Script-less certificates

given to Shareholders in return for their Investments in the

company, as proof of ownership.

What is the Share Price? Par Value: Nominal price of a share

Issue Price: Price at which new shares are issued to market Determinants: - Share pricing models or - Issue price of similar companies in the industry

Market Price: Share Price determined by the market factors Determinants: - Demand and supply - Company’s position and performance - Future expectation on the company - Company’s future plans and strategies - Changes in company’s management panel - Any shocks in the industry - External environmental factors

Share MarketWhat is Share Market?Common market place where shares are traded

Types: Primary share market – - Market for issuing new shares of the company - Transactions between Companies or Investment banks on behalf and Stock brokers or Institutional investors - Issue prices decided by the company/ investment bank is the Share price

Secondary share market – - Market for day to day share trading - Transactions between individuals and institutional investors through stock market brokerages - Market price determined by market factors is the Share price

Share Pricing Models

Types:Method 1 Absolute share pricing models – Uses company’s asset base/ cash flows/ earnings/ dividends

Relative share pricing models – Uses comparative information of other similar size companies

Method 2 Asset based pricing models – Uses company’s net asset base Income based pricing models – Uses predictions on income generating ability Cash flow based pricing models – Uses predictions on cash flow generating ability

Importance These predict future prices and profitability of shares Share pricing becomes relevant in making ‘Buy, Sell or Hold’ decisions of investments

Net asset based share pricingShare pricing formulaPrice per share = Total Net Asset Value Number of Shares

Net Asset Value can be calculated using, Book value Net realizable value Replacement value

Using Net realizable value is more prudent as assets and liabilities are valued at their market prices

Price Earnings (PE) multiple share pricingShare pricing formula

Price per share = PE ratio X Earnings Number of SharesPE ratio is an indicator of share profitability and attractiveness to investPE ratio is calculated as, PE ratio = Market Price per share OR Market Capitalization Earnings per share Total Earnings

In this method, Step 1: Average PE ratio for the industry is calculated Step 2: Applied to the company to estimate its share price and may be discounted by 1/3 or 1/2

Discounted Cash flow based share pricing

This model estimates the cash flows that the company would generate for foreseeable future and discounts to obtain present value

Discounted free cash flows are usedFree cash flow = Operating cash flow – Capital expenditure

Using free cash flow to firm, WACC is the discounting factorShare pricing formula Price per share = Value of the Firm – Market Value of Debt

Number of SharesUsing free cash flow to equity, cost of equity is the discounting factorShare pricing formula Price per share = Value of Equity Number of Shares

Discounted dividend based share pricingThis model estimates the dividends that the company would pay shareholders for foreseeable future and discounts to obtain present value

Share pricing formulaPrice per share = Dividend Per Share (1 + growth rate)

Return for shareholders – growth rate

Dividend growth rate can be estimated using, Historical data Gordon’s growth model

Return for shareholders can be determined using, Capital Asset Pricing Model

Residual income based share pricingThis model estimates the Residual Income, i.e. even after Equity Charge, for foreseeable future and discounts to obtain present value

Share pricing formulaPrice per share = Residual Income per share (1 + growth rate)

Return for shareholders – growth rate

Residual Income = Net Income – Equity Charge

Equity Charge = Equity Capital X Cost of Equity

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