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Sir, can you please explain me these points.
1) Is it true that we can do a valuation on the ‘value of the company’ (i.e. its shares value in the market) by using various methods such as: PE ratio; Earning Yield method; DVM; Market Capitalization or else (if there are any other methods please name few more)
2) How can we know based on the above methods about the company’s performance. Is that correct that we as investors simply use these methods before investing our money in the company (i.e. buying the shares of the company) to know how well the company might be doing in future & once we are certain that the share price of the company is going to be higher then we surely take a step of buying its shares?
Thank you 🙂
1. Yes, there are various ways of valuing a company as you have listed (plus an asset valuation).
2. The purpose of valuing is not to value the shares on the stock exchange (if it is a quoted company) – the market value of shares is determined by the shareholders and in theory is the present value of future dividends. The purpose is either because the company is not quoted on the stock exchange, or because another company is considering buying the company and deciding on how much to offer for the purchases.
I explain all of this in my free lectures on the valuation of a company. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
1) You mentioned Asset Valuation which I assume also called Net Assets Method (Total Assets – Total Liabilities) which is actually Equity of the company which is used to measure the value of a company.
2) How is it possible or logical that the market value of shares is determined by the shareholders! (I’m puzzled) because I thought it was the stock market that set the MV of share price for shareholders by taking demand & supply into consideration to set the share price.
(I’m thinking that if shareholders are allowed to set MV of shares then they will set such a high market value which could be overvalued so that they can sell at high value earning more profits?)
3) Is Net Asset Method is actually the most common way to measure the value of the company which is actually the Equity of the company (or any other ratios that I mentioned above which is most common) & whether it is used by the company specifically to know the worth of their company (in case they want to liquidate the company)?
4) Equity section in SOFP simply represents the worth of the company. Anyone considering buying the company will simply be looking at the company’s SOFP to know its worth & how much to offer for the purchases?
Thanks for your previous reply. It was worth great help 🙂
1. Yes, an asset valuation is the net assets method and is valuing the equity (either using book values or actual values depending on the information given in the question.
2. The market value on the stock exchange is determined by the shareholders because the traders adjust the values daily in order to match the supply (by sellers) with the demand (by buyers). The market value is the price at which sellers are prepared to sell and the buyers are prepared to pay.
3. No – the net assets method is not the most common way to measure the value of the company. It is only usually relevant if the company is being taken over or is being liquidated. Most companies are not in either of those situations, and the share price is determined by the shareholders expectations of future dividends.
4. Anyone considering buying a company will certainly not just look at the company SOFP. The SOFP is showing the book values of the assets which are extremely unlikely to mean much at all – they do not show the true values of non-current assets.
I do explain all of the above in my free lectures on the valuation of shares.
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