Valuation of equity sahres

VALUATION OF EQUITY SHARES BASED ON DIVIDEND

1. VALUATION OF EQUITY SHARES ( Based on Dividend ) DR. MOHAMED KUTTY KAKKAKUNNAN Associate Professor P.G. Dept. of Commerce N A M COLLEGE KALLIKKANDY Kannur – Kerala - India

2. Valuation of Equity Shares Value of equity shares can be ascertained 1. On the basis of capitalization of dividends and 2. On the basis of capitalization of earning 1. Capitalization of Dividends As per this model the value of equity is a function of the cash inflows expected by the investors and risk associated with the cash follows Investor expects earning dividends and capital gain there on the sale of shares Thus, the value of equity share is the present value of the expected stream of future dividends

3. Further, while valuing the equity shares, the intention of the investor need also be considered. Thus, there are different models a). One period valuation model Here the investor, supposes to purchase shares and sell it at the end of the year. The value of shares in this case will be the present value of dividends at the end of the year plus the present value of the expected sale price at the end of the year Where Po = current price of share; D1 = dividend at the end P1 = Price of the share at the end of the year Ke = required rate of return on equity shares

4. Two period valuation model n- year valuation model

5. Dividend Valuation Model Common model Assume that the investors wish to hold the share for long (indefinite or infinite) period In this case value of share will be equal to the capitalized value of infinite stream of future dividends In this model also there are variants A- No Growth Case No growth – dividends remain constant over infinite period Here value is ascertained by the capitalization of the perpetual stream of constant dividends

6. B. Constant Growth Case Dividends are expected to grow at a constant rate forever C. Supernormal growth Dividends are expected to grow at a supernormal growth during the periods when the firm is experiencing high demand for its products and then the dividend grows at a normal rate when demand reaches the normal level In this case the above equation is to be suitably modified to find out the present value of a share

7. In this case the dividends are expected to grow at a supernormal growth rate for ‘ g s ‘ , for n years and them grow at a normal rate ‘ g n ‘ till infinity, the present value of the share an be calculated Steps involved 1. Calculate the present value of expected dividends during supernormal growth period 2. Calculate the present value of the share at the end of the supernormal growth

8. 3. Discount Pn back to Po to find out its present value at ‘t=0’ 4. Add the present value of expected value of dividends as calculated in step 1 with the present value of Po as calculated in step 3