Equity Valuation at one go!Terms generally associated with Equity Valuation

Book Value (BV) of Equity = Assets – Liabilities (on balance sheet date) Market Value (MV) of Equity = Total number of firms’s outstanding shares *

Market Price Return on Equity (ROE) = (Net Income – Preferred Dividends) / Average Book

Value Average Book Value = (BVt – BVt-1) / 2 Average Book Value = Net Income/BVt-1 (If BV is stable over different periods) Price to Earning (PE aka Market to Book Ratio) = MV of Equity / BV of Equity

Equity Valuation – Fundamental & Technical AnalysisWhile doing Equity analysis and specifically stock picking, two types of approaches are widely used:

Fundamental analysis and Technical analysis.

While Fundamental analysis is aimed at deriving the intrinsic value of stock, Technical analysis lays emphasis on market movements of prices, volumes etc. This paper will talk about Fundamental analysis and different methods used for determining Intrinsic value of shares.

Equity Valuation Models (for doing Fundamental analysis)

Balance Sheet Methods, as the name suggests are based on data available in the balance sheet.

Book Value Method

Book Value of Equity => Net Worth of the Company

Net Worth = Equity Share Capital + Reserves & Surplus + Preference Share Capital – Miscellaneous Expenditure (in Balance Sheet) – Accumulated Losses

Liquidation Value Method

Liquidation Value of Equity = Net Realizable Value of all assets – Amount paid to all Creditors including Preference Shareholders

Replacement Value Method

Value of Equity = Replacement cost of assets – Liabilities

Discounted Cash Flow Methods, finds Present Value of future cash flows to derive Present Value of Equity. The following chart shows, different models used for different periods of dividends and different dividend growth assumptions.

Single Period Model

Value of firm = Net Income / Discounting Rate

Stock Price = (Expected Dividend after year 1) /(1+Discounting Rate) + (Expected Price after year 1) /(1+Discounting Rate)

Multi Period Model

Stock Price = {D1/(1+R)} + {D2/(1+R)2} + {D3/(1+R)3} +…………………+ {DN/(1+R)N}Where,D1 = Dividend after year 1D2 = Dividend after year 2 & so onR = Expected Rate of Return or Cost of Equity

Equity Valuation Methods

Balance Sheet Methods

Book Value

Method

Liquidation Value

Method

Replacement Value Method

Discounted Cash Flow Methods

Dividend Discount

Model

Free Cash Flow

Model

Relative Valuation Methods

P/E Method

Price to Book Value

Method

Price to Sales

Method

Dividend Discount Models

Single Period Model

Multi Period Model

Zero Growth Model

Constant Growth Model

Two Stage Growth Model H Model

Zero Growth Model

Stock Price = Annual Dividends / Required Rate of Return

Constant Growth Model

Stock Price = D1 / (K-G)

Where,D1 = Dividend after year 1K = Required Rate of Return or Discount RateG = Expected Constant Growth Rate

Two Stage Growth Model

Stock Price = {D1/(1+R)} + {D2/(1+R)2} + {D3/(1+R)3} +…………………+ {DN/(1+R)N} +[{DN (1+G2)/(R-G2)}/(1+R)N]

Where,D1 = Dividend after year 1R = Required Rate of Return or Discount RateG = Growth RateG2 = Growth Rate at stage 2N = Number of years

H Model

Stock Price = {D (1+G2)}/(R-G2)+ {(D*H*(G1-G2)}/(R-G2)

Where,D = Current year DividendR = Required Rate of Return or Discount RateG = Initial Growth RateG2 = Terminal Growth RateH = Half of anticipated transition

Free Cash Flow Model

Calculation and approach is similar to the Dividend Discount models the only major difference being that instead of Dividends, Free Cash Flows are used for equity valuation.

Free Cash Flows = Operating Cash Flow – CAPEX

Relative Valuation Methods, are also known as Comparable methods because they use peers or competitors value to derive at the value of equity.

P/E or Price to Earnings Ratio = Market Value Per Share / Earnings per share

Price to Book Value aka Price Equity Ratio = Stock Price / Book Value of Share

Price to Sales = Price per share / Annual Sales per share