share pricing | finance
TRANSCRIPT
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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