The document discusses share valuation, focusing on the comparison between intrinsic value and market price for investment decisions. It explains various concepts of value, such as book value, market value, and intrinsic value, and outlines methods for calculating the present value of expected future cash flows from dividends and resale. Additionally, it presents share valuation models, including the constant growth model and multiple growth model, to estimate intrinsic value based on expected dividends and growth rates.

1. Portfolio Management
LECTURE SIX
Share Valuation
Prepared By:
Noorulhadi Qureshi
Lecturer Govt College of Management Sciences
Peshawar

2. Share Valuation
• The Fundamental analysis and investment
decision is to buy or sell a share is based on
comparison between the intrinsic value of a
share than its market price.
• If Market price < intrinsic value : Purchase the share
– (Under Price Consideration)
• If Market Price > intrinsic value : sell the share
– (Over Price Consideration)

3. What is Value?
 In general, the value of an asset is the price that
a willing and able buyer pays to a willing and
able seller
 There are several types of value, of which we
are concerned with three:
 Book Value - The asset’s historical cost less its
accumulated depreciation
 Market Value - The price of an asset as determined
in a competitive marketplace
 Intrinsic Value - The present value of the expected
future cash flows discounted at the decision maker’s
required rate of return

4. Concept of Present Value
• Time Value of Money
(TVM) concept that a
F
rupee received now is
worth more than a rupee PV = Σ
to be receive after one
years, TVM suggests that (1 + k )n
earlier receipts is more
desirable than later
receipt, because it can be
reinvested to generate
additional return..

5. F
PV = Σ
(1 + k )n
• F is the amount to be received after n period
• N is the number of years
• K is the discount rate
• PV is the present value
• For example if Rs.500 would received after 2
years and discount rate is 10% the PV can
be calculated: P= 500/(1.10)2
• =413.22

6. Common Stocks
• A share of common stock represents an
ownership position in the firm. Typically,
the owners are entitled to vote on
important matters regarding the firm, to
vote on the membership of the board of
directors, and (often) to receive dividends.
• In the event of liquidation of the firm, the
common shareholders will receive a pro-
rata share of the assets remaining after
the creditors and preferred stockholders
have been paid off.

7. Preferred Stock
• Preferred stock represents an ownership
claim on the firm that is superior to
common stock in the event of liquidation.
Typically, preferred stock pays a fixed
dividend periodically and the preferred
stockholders are usually not entitled to
vote as are the common shareholders.

8. Share Valuation Model
• The valuation model used to estimate the
intrinsic value of a share is the present
value model.
• The intrinsic value of a share is the
present value of future amount to be
received in form dividend and resale of
share.

9. One Year holding period
• Investors intends to
purchase a share and
hold it for one year D S
So = +
and sell it at the end (1 + k )1 (1 + k )1
of year. Investor
expects to receive
dividend and resale
price of share.

10. D S
So = +
(1 + )
k 1 (1 + )
k 1
• D is the amount of dividend
• So is the Present value
• K is the discount rate /required rate of
return
• S is the selling price after one year

11. D S
So = +
(1 + )
k 1 (1 + )
k 1
For example, if an investor expects to get
Rs. 3.5 as dividend from a share next year
and sell at Rs. 45, if required rate of return
is 25% the present value will be
3.5 45
So = +
(1.25)1 (1.25)1
So = .8 +
2 36 = .80
38

12. Multiple-Year holding period
• Investors intends to purchase a share and hold
it for more than one year and sell it at the end
of that period. Investor expects to receive
annual dividends and resale price of share.
D1 D2 Dn + Sn
So = + .... +
(1 + k )1 (1 + k )2 (1 + k )n
• D is the dividend of each years
• S the sale price at end of holding period
• K is the required rate of return
• n is number of holding periods.

13. D1 D2 Dn +Sn
So = + .... +
(1 +k )1 (1 +k )2 (1 +k )n
For example investor expects to get Rs.3.5, Rs. 4
and Rs. 4.50 as dividends for 1st three years and
sell at Rs. 75. the required rate is 25%, what is
the present value.
3.5 4.00 4.50 75
So = + + +
(1.25)1 (1.25)2 (1.25)3 (1.25)3
So =46.06

14. Constant Growth Model
Do(1 + g )
So =
k−g
In this model the dividend will grow at constant rate g into indefinite. This model
shows the intrinsic value of a share is equal to next year’s expected dividend
divided by th difference between the appropriate discount rate for the stock and its
expected dividend growth rate.
The constant growth model is also known as Gordon’s share valuation model,
named after the model’s originator, Myron J. Gordon.

15. Constant Growth Model
A company has declared a dividend of Rs. 2.50 per share for the current year. The
company has been following a policy of enhancing its dividends by 10% every year
and is expected to continue this policy in the future also. An investor who is
considering the purchase of the shares of this company has required rate of return
of 15%. The intrinsic value of the company’s share can be calculated as
Do(1 +g ) 2.5(1 +.10)
So = So =
k −g 0.15 −0.10
So = Rs.55
The investor should purchase if the current market price is lower than Rs. 55.

16. Multiple Growth Model
• In many cases the constant growth rate may not be
realistic. In MGM the future time period is viewed
as divisible into two different growth segments.
Different variation growth and constant growth. i.e.
• So = value with different rate + value with constant rate
• So= V1+ V2
D1 D2 Dn
V1 = + + ..... Dn(1 + )
g
(1 + k )1 (1 + k )2 (1 + k )n V2=
( k − )(1 + ) n
∑
g k
Dt
V1 =
(1 + K )t
So = v1 +v 2
So = (
∑ Dt
(1 +K )t
) +(
Dn(1 + g )
( k −g )(1 +k ) n
)

17. Multiple Growth Model
Consider a company paid a dividend of Rs. 2 per share next
year. And pay dividend of Rs. 3 and 3.5 in next
consecutive years. After that an annual constant growth
at 10% is expected to indefinite time. If the required rate
of return is 20 %, what is the intrinsic value
2 3 3.50
V1 = + +
(1.2)1 (1.2) 2 (1.2)3
= 5.787
Rs
3.50(1.1)
V2 =
0.20 − .10)(1.2)3
0
=Rs 22.28
So = 1 + 2
V V
So = .78 + .28
5 22
So = .06
28
The investor should purchase if the current market price is lower than Rs. 28.06.