Equity Valuations simplified

1. Equity Valuation at one go!
Terms generally associatedwith 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 Analysis
While 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.

2. Equity Valuation Models (for doing Fundamental analysis)
Balance Sheet Methods, as the name suggestsare basedon data available inthe balance sheet.
Book Value Method
BookValue of Equity => NetWorth of the Company
NetWorth = EquityShare Capital + Reserves&Surplus+Preference Share Capital –Miscellaneous
Expenditure (inBalance Sheet) –AccumulatedLosses
LiquidationValue Method
LiquidationValueof Equity=NetRealizable Value of all assets –Amountpaidtoall Creditors
includingPreference Shareholders
ReplacementValue Method
Value of Equity= Replacementcostof assets – Liabilities
Discounted Cash Flow Methods, findsPresentValue of future cashflowstoderive Present
Value of Equity. The followingchartshows,differentmodelsusedfordifferentperiodsof dividends
and differentdividend growthassumptions.
Single PeriodModel
Value of firm= NetIncome / DiscountingRate
Stock Price = (ExpectedDividendafteryear1) /(1+DiscountingRate) +
(ExpectedPrice afteryear1) /(1+DiscountingRate)
Multi PeriodModel
Stock Price = {D1/(1+R)} + {D2/(1+R)2
} + {D3/(1+R)3
} +…………………+ {DN/(1+R)N
}
Where,
D1 = Dividend after year 1
D2 = Dividend after year 2 & so on
R = Expected Rate of Return or Cost of Equity

3. Zero GrowthModel
Stock Price = Annual Dividends/RequiredRate of Return
Constant Growth Model
Stock Price = D1 / (K-G)
Where,
D1 = Dividend after year 1
K = Required Rate of Return or Discount Rate
G = 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 1
R = Required Rate of Return or Discount Rate
G = Growth Rate
G2 = Growth Rate at stage 2
N = Number of years
H Model
Stock Price = {D (1+G2)}/(R-G2)+{(D*H*(G1-G2)}/(R-G2)
Where,
D = Current year Dividend
R = Required Rate of Return or Discount Rate
G = Initial Growth Rate
G2 = Terminal Growth Rate
H = Half of anticipated transition
Free Cash Flow Model
Calculationandapproachissimilartothe DividendDiscountmodelsthe onlymajordifference being
that insteadof Dividends, Free CashFlows are used forequityvaluation.
Free CashFlows= OperatingCashFlow – CAPEX
Relative Valuation Methods, are alsoknownas Comparable methodsbecause theyuse peers
or competitorsvalue toderive atthe value of equity.
P/E or Price to Earnings Ratio = Market Value PerShare /Earningsper share
Price to Book Value aka Price Equity Ratio = Stock Price / Book Value of Share
Price to Sales= Price pershare / Annual Salespershare