This document discusses various approaches to valuing equity shares, including accounting-based methods like book value and liquidation value, and dividend-based methods like the single-period, multi-period, and constant/variable growth dividend discount models. It also covers valuation using the price-earnings (P/E) ratio and models like Graham-Dodd and Whitbeck-Kisor that use factors like earnings, growth rates, and dividend yield to determine fair value.

1. STOCK RETURN AND VALUATION

2. Features of Equity shares:
 Uncertainty
 No Redemption
 Relation with earning of the company
Approaches to valuation:
 Accounting concept of valuation
 Valuation based on dividends
 Valuation based on earnings

3. ACCOUNTING CONCEPT OF VALUATION
Book Value or Balance Sheet Value:
BV = (Equity Share Capital + accumulated profits – all
accumulated losses)/ No of equity shares
 BV is based on accounting information and can be
easily calculated.
 It ignores profitability of the firm.
 It is subjective as it is based on the historical figures.
Liquidation Value:
Amount of cash that would be received from the
company if all the assets are sold and liabilities are
paid.
 It is better and realistic than BV.
 It does not consider profitability of the firm.

4. VALUATION OF EQUITY SHARES BASED ON
DIVIDENDS
Assumptions:
 The dividends are payable annually
 The first dividend is received after one year
from the date of acquisition/purchase
 Sale of equity share, if any, occurs only at the
end of a year

5. HOLDING PERIOD RETURN
P(t+1) – P(t) + D
r = ----------------------
P(t)
Price Change + Cash Dividend
r= -------------------------
Purchase Price

6. DIVIDEND YIELD
Dividend
DY = ---------------------
Purchase Price
Price Change
Capital Gain Yield = ------------------
Purchase Price

7. DIVIDEND DISCOUNT MODELS
Single Period Valuation Model:
Assumptions:
 Investor holds the stock for a year
 Return occurs at the end of the period.
D1 P1
P0 = ------- + --------
(1+r) (1+r)
Where P0 =Present Selling Price, P1= Selling Price at
the end of one year holding period, D1= Dividend
received during 1 year holding period, r= required rate
of return

8. MULTI- PERIOD MODEL
 The investors may hold the shares for
several years.
Assumptions of Dividend Patterns:
 Zero growth in dividends
 Constant growth in dividends
 Variable growth in dividends

9. ZERO GROWTH IN DIVIDENDS
Po = D / r
Where Po = value of equity share, D = Annual
Dividend, r = required rate of return.
 Dividend expected at end of year 1 will help
to find the value of equity share.
 However the assumption of constant
dividend is unrealistic.

10. CONSTANT GROWTH IN DIVIDEND
Assumptions:
 The dividend will grow constantly at a rate, g , every
year.
 The growth rate is less than the required rate of
return of the investor.
 The growth rate is the subjective estimate of
investors.
Dt = Dt-1(1+g) t
D1 = D0(1+g)1
P0 = D1/ (r-g) and r = (D1/P0 ) + g

11. VARIABLE GROWTH IN DIVIDEND-TWO STAGE
GROWTH MODEL
 Growth stages are divided into two – a period
of extraordinary growth and a constant
growth of infinite in nature.
 Present Value of the stock =
PV of dividend during the above normal growth
period
------------------------------------------------------------------
--------------
PV of stock price at the end of the above normal
growth period

12. TWO STAGE GROWTH MODEL FORMULA
P0 = N D0 (1+gs)t DN+1 1
Σt=1 ------------------- + --------- x -----------
(1+rs)t (rs-gn) (1+rs)N
D0 = Dividend of the previous period
gs = Above normal growth rate
gn = Normal growth rate
rs = Required rate of return
N= Period of above normal growth

13. THE THREE PHASE MODEL
 Three phases of dividend growth pattern is
assumed.
 Phase A- Dividends are assumed to grow at
a constant rate ‘g’ for A years .
 Phase B– After ‘A’ years the growth rate of
dividends declines for A+1 years and the
decline would be linear.
 Phase C – Perpetual growth rate ‘gn’

14. THE THREE PHASE MODEL FORMULA
A D0(1+ga)t
B Dt-1(1+gb)
DB(1+gn)
P0 = Σ ----------------- + Σ------------------ + -----
-----------
t=1 (1+r)t t=A+1 (1+r)t r-g
n(1+r)B

15. VALUATION THROUGH P/E RATIO
 P/E ratio indicates price per rupee of share earnings.
Stocks with different EPS can be compared.
 It is helpful in analysing the stocks of the companies that do
not pay dividend but have earnings.
 This method is easier to estimate.
P/E = d/e
-----------
r-g
d/e= dividend payout ratio, r= required rate of return, g =
growth rate
If growth is the function of return on equity , then:
P/E = d/e
---------------------------
r- ROE (1- d/e)

16. GRAHAM – DODD Model:
 Stocks that have a high earning to price
ratio, a high dividend yield, a price below its
book and net current assets value are the
best picks in the stock market.
Price = Earnings (8.5 + (2 x Growth))
Whitbeck-Kisor Model:
P/E = 8.2 + 1.5g + 0.067D/E -0.2
Theoretical P/E > Actual P/E  Sell
Theoretical P/E > Actual P/E  Buy