16. The valuation of securities - Practical issues

What are limitations of the dividend valuation model?

• Stock exchange is not perfectly efficient

  • Therefore, the market value of a share may be distorted from day-to-day by factors such as rumours about a takeover bid

• Market values do not can be instantly on changes in expectations

  • The speed at which the market value changes depends on the volume of business in the share

• The model only deals with constant growth dividends, in practice this may not be the case

  • However, do appreciate that the growth used in the model is the future growth that shareholders are expecting

    • This is perhaps more likely to be at a constant rate

  • The big problem is determining the rate of growth that shareholders expect

    • It is clearly impossible to ask them and to any estimate that we make for our calculations is only an estimate and can be completely different from the rate of growth that shareholders are in fact expecting

What are the practical approaches to valuing shares in unquoted companies:

Net assets basis and Earnings basis

What is net assets basis?

Value per share = (Value of net assets / no.shares)

On what basis do we value the net assets?

Realisable value - Only sensible if the company was about to be wound up

Replacement value - More sensible from the point of view of another company considering making an offer for the shares in our company

Book value - Normally of little relevance since the book values of assets are unlikely to even approximate to the actual values

What is the earnings basis?

Uses the price earnings ratio of a similar unquoted company

• P/E ratio = (Market value p/share / EPS)