TOPIC 4

(CHAPTER 4)

VALUATION OF SHARES

1
Updated: Sept23
LEARNING OUTCOME:
At the end of this lecture, students should be able to:
Explain the:
1. The need to do business valuations
2. Assets-based valuation models
3. Income-based valuation models
4. Cash-flow valuation models

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Updated: Sept23
CONTENTS:

2- Assets-
1- Business
based
valuations
valuation

3- Income- 4- Dividend
based valuation
valuation model

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Updated: Sept23
 1- BUSINESS VALUATIONS

1.2- Why
1.1- are 1.3- Stock
Definition of Valuations Valuation
valuation of Shares Approaches
Needed?

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Updated: Sept23
1.1- Definition of Valuation
• Process of estimating the true value of an asset which is known as INTRINSIC
VALUE max priceto pay
willing
investor
• expected worth of the stock on paper
• fundamental value or fair value or theoretical value
• maximum price investor are willing to pay
• minimum price investor are willing to sell

• Main use: to predict future price – potential market price

buy
sell/not to

• Undervalued ~
Mr vs IV
Future
• Overvalued - -
Mr > Iv >
- overvalued >
-
decrease
Increase
12 > undervalued ->
-

② - Mr >
↑
Buy/ buy more

To help in decision making.

-

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Updated: Sept23
1.2- Why are Valuations of Shares Needed?

1. Private company: To fix an issue price to be listed.

2. M&A: Takeover bid and the offer price
3. Restructuring/ divestment: When a group holding company is negotiating the
sale of its subsidiary to a management buyout team or to an external buyer.
the
4. As collateral: For a company to secure a debt financing. kena value
share

5. Disposal of shareholding in private company: When a shareholder wishes to

dispose of his holding (large or controlling interest).
6. Investment appraisal: When an investor is considering whether it is worth his
money to buy or profitable to sell a particular stock
7. Liquidation: When a company is being broken up due to bankruptcy need to
be valued in order to ascertain the value of proceeds to be received from
assets disposed.

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Updated: Sept23
1.3- Stock Valuation Approaches

Xan
The asset-based
valuation method
The income-
based valuation
method (Relative
valuation method)
The dividend
valuation method
(Discounted Cash
Flow method)

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Updated: Sept23
 2- ASSETS-BASED VALUATION

• Determines a company’s ordinary share value by analyzing the value of the

company’s assets.
• Main difficulty establishing the basis of asset values to use.
• Asset valuation can be based on:
1. Historic cost basis/book value: Easily found but not a reliable indicator of
current market values of assets of the firm
2. Net realizable /break-up value: Represents what would be left for the
shareholders if the tangible assets were sold off and the liabilities settled
immediately. Minimum selling price.
3. Replacement value: Buyer of a business will be interested in the replacement
cost. Understate the true value of the business, complicated and difficult in
practice

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Updated: Sept23
 2- ASSETS-BASED VALUATION (Cont’d)

• How to calculate?
1. The value of an ordinary share:
Net tangible assets > Asset
- - Liabilities

Number of ordinary shares outstanding

2. Intangible assets (including goodwill) should be excluded, unless they have a

- -

market value (for example, patents and copyrights, which could be sold).
• Weaknesses:
1. Assumes that investors normally buy a company for its balance sheet assets.
2. Ignores non-balance sheet intangible assets which may include a strong and
experienced management team and highly skilled workers.

• Example- page 128-129 (NRV)

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 3- INCOME-BASED VALUATION

• Apply the price-to-earnings ratio (P/E) or earning multiplier model.

• One of the most common methods for valuing share price.
Market price per share
Capilizatio
one

• P/E ratio =
Earnings per share
& market

• By selecting a suitable P/E ratio and multiplying this by the EPS, the market
price per share or the total value of a company can be computed.
• The Intrinsic value of a stock (Market price per share) = EPS x P/E ratio.
• Value of a company (market capitalization) = Total earning x P/E ratio

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Updated: Sept23
 3- INCOME-BASED VALUATION (Cont’d)
~..
EXAMPLE (page 122) Find instrinsic value

The latest financial statements of food retail company Kesang Berhad, show
earnings per share of RM0.20 and the average P/E for the companies in the same
industry is quoted at a ratio of 15 at the time of valuation.

A possible value could be computed as follows:

RM 0 20 x 15
• The market price per ordinary share is RM3 >
.

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Updated: Sept23
 3- INCOME-BASED VALUATION (Cont’d)
~.
EXAMPLE Need to find EPS first, then Intrinsic value. after that make decisions

Seri Indah Bhd’s expected earnings after taxes (EAT) is RM300 million. The current
market price of its common stock is RM5.00 per share. At present the company has 500
million shares outstanding and a PE ratio of 10.
i- Calculate the intrinsic value of Seri Indah Bhd’s common stock.
IV = P/E x EPS
EPS
RM
= 10 x L & = RM6.00
-
10 60 X
.
10
RM6
ratio

ii. Would you buy the share at its current price? Why?
Yes, because the market price of the common stock is undervalued. IV > market
price.

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Updated: Sept23
 3- INCOME-BASED VALUATION (Cont’d)

>
EXAMPLE (page 123) Expected value in the future

Assume Hibiscus Bhd has a current P/E ratio of 10 and its current EPS is RM1.10. It has
increased its EPS by 4% annually in the past and this rate is likely to continue for some
time. If the P/E ratio is expected to increase to 15 in five years, what is the stock price
expected to be in year 5?
=
5
1 . (1 04) x 15
.
= 20 075
.

Ix
Solution:
Pt = 15 x RM1.10 x (1.04)5 = RM20.07
Therefore, the stock price is expected to be RM20.07 in five years.

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Updated: Sept23
 3- DIVIDEND VALUATION MODEL
• Based on the theory, the equilibrium price for any security depends on the future
expected stream of income from the Dsecurity discounted using an appropriate cost of
capital or a required rate of return.-Kirn pr (present value)
- -

--
• John Williams (1938) stated that the price of a stock should reflect the present value
of the share’s future dividends.
-

• In equation form, this is the statement of the DVM: Dividend

paid in time t
=
+

The required rate of

return by investor
PV of future
at the time of
cash flow
valuation t

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Updated: Sept23
 3- DIVIDEND VALUATION MODEL (Cont’d)

• Appropriate for mature and profitable companies that have a history of dividend
payments and a consistent dividend policy
• Less suitable for companies that are engaged in a fast-growing segment of the
economy in which the focus is more on share price appreciation overtime for a
capital gain objective.
• The general model can be formulated if the company’s dividends are expected to
follow these basic patterns:

3.1- Zero 3.2- Constant 3.3- Differential

Growth growth constantly x/ growth
Dividend is same every year
. increase increse year
.
dividend changes
exemple every year ,
:

event
For

(D0 = D1 = D2 (Dt = Dt-1

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Updated: Sept23
3.1- Zero Growth

• Assumption:
1. Same amount of dividend is paid every year (zero growth)
2. The required rate of return for the share remain constant at ke which is
equal to the cost of equity for that company.

cash flow (IV)

PV of future
D D D
Price (P0 ) .....
(1 ke ) (1 ke ) 2 ke
where
D = Constant annual dividend
ke = Shareholders’ required rate of return
P0 = Intrinsic price of the stock

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Updated: Sept23
3.1- Zero Growth (Cont’d)
EXAMPLE (page108)
fixed dividend
Find the price of a share of preferred stock given that the par value is RM10 per
share, the preferred dividend rate is 8% and the required return rate is 10%.
s .
Price( )( ) = = = -
. e % 10

EXAMPLE
Mara Berhad is expected to pay a dividend of RM1.10 per share every year in the
foreseeable future. Investors require a return of 15% on investment in the
company’s shares. Applying the DVM, what is a fair price for the company’s
share?
.
Price( )( ) = =
=
V
0 15
.

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Updated: Sept23
3.2- Constant Growth
• Useful for valuing stable-growth, dividend paying companies
• Assumption:
1. Company pay dividend that has current value of D0.
2. Dividend grows at a constant rate.
( + ) ( + ) ( + )
Price (P ) = + +. . . . . = =
( + ) ( + ) ( )

Where;
PV of future
D0 = The most recent dividend paid
cash flow (IV)
g = Constant growth rate in dividends
D0 (1+g) = Expected dividend in one year’s time (D1)
Ke = Shareholders’ required rate of return
P0 = Market value excluding any dividend currently payable

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Updated: Sept23
3.2- Constant Growth (Cont’d)

EXAMPLE (pg 109)

Eurix Bhd has just paid its shareholders a dividend of RM0.10 per share. The required
rate of return is 8% and dividends are expected to grow at 5% in perpetuity. Compute
the intrinsic value of Eurix’s stock. You are a shareholder of the company, and if the
current market price is RM4.50, should you buy more of Eurix’s shares for your
investment portfolio?

. ( + . )
Price( ) = = = 3.
. .

As the intrinsic value of RM3.50 is below the current price of RM4.50, the stock is
overvalued. Thus, no additional purchase of Eurix’s stock is necessary.

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Updated: Sept23
3.2- Constant Growth (Cont’d): Expected growth rate of
dividends (g)

Dividend in year T-t x (1+ g)T-t = Current Dividend (D0)

D T-t x (1+g)T-t = D0

EXAMPLE
A company is just about to pay a dividend of RM0.50 a share this year. Four years ago, its
dividend was RM0.25 a share. What was the average annual growth rate of dividends over
the four years?
Dividend 4 years ago x (1 + g) 4 = Current Dividend
(1 + g) 4 = Dividend this year / Div.four years ago 1891 + g = 1 .

9 1189-1
-
=

= RM 0.50/RM 0.25 = 2

↑
= 184
0 .

lyrs ryrs 3yrs 4/

1 .

4yrs D
=

(1 + g) =2¼ D
-s e e
(1 9) = 1.189
+
# + I
0 25 0 56
Therefore g = 1.189 – 1 = 0.189 = 18.9%. growthe
.
.

= 4yrs

20
i
-

20 bq
: 2
Updated: Sept23 = -
3.2- Constant Growth (Cont’d): Expected growth rate of
dividends (g)
DPR ps
I
=

EXAMPLE
( + )
Price (P ) =
• No. of shares : 10 million ( )
• Current Stock Price: RM5.85 Answer:
• EPS: RM0.60 D0 = 70% * RM0.60 = RM0.42
• Proposed payout: 70% Div 2 years ago x (1 + g )2 = Proposed div.
• Div. per share 1 year ago: RM0.41
0.40 (1+g)2 = 0.42
• Div. per share 2 years ago: RM0.40
1+g = (0.42/0.4)1/2 = 1.051/2
↑

• Beta: 1.5

CAPEM
Find Ke
restment
:

• PE: 11
costof capit g = 1.0247 – 1 = 2.47%
• Risk Free rate: 4% ↓ ↓ Ke
• Market Return: 8% Ke R = Rf + beta (Rm - Rf) = 4 + 1.5 (8-4) = 10%

Calculate intrinsic value of the stock. IV = 0.42 (0.1+0.0247)/(0.1-0.0247) = RM5.72

1 +g)
4 IND2 Refer Example 7 (page 110)
Mo (
-0
.

21
-

Updated: Sept23 ke-g >

-
3.2- Constant Growth (Cont’d): Expected growth rate of
dividends (g) Dividend
Retention Ratio
It
[Retained (b) retation

E
-

ratio
Earning retention model: g = b x r
where,
b = the expected retention rate = 1 – D/E (Dividend Payout Ratio)
r = the expected accounting rate of return or return on capital employed (ROCE) or
- -

return on investment (ROI) or return on equity (ROE)

-

> -
-
-

EXAMPLE (page 111-112) Answer:

Dividend per share = EPS x DPR = RM5 x
• ROE: 15% 0.4 = RM2
• Expected EPS in coming year: RM5.00 Retention ratio = 1 – 0.4 = 0.6 or 60%
• Required rate of return: 14% Ke retention ratio

• Dividend payout ratio: 40% (DPR) g = ROE x (i

RR = 15% x 0.6 = 0.09 or 9%

Calculate intrinsic value of the stock. -

IV = 2 / (0.14 - 0.09) = RM40

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Updated: Sept23
3.3- Differential Growth Model 1)
(Stage 2)

H3
(stage
erkennity -

6%
2/ 3% 5/
, I
• Two stages growth period;
1. Variable growth O Po ⑭ O
Pr

2. Constant till perpetuity or grow at constant rate till perpetuity

• The intrinsic value of the ordinary share can be computed as follows:

P1 + P2
PV period 1 (variation) + PV period 2 (constant)

PV of future
cash flow

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Updated: Sept23
3.3- Differential Growth Model (Cont’d)
EXAMPLE (page 114) -

Macy Berhad paid RM1.50 dividend per ordinary share last year. The company's
policy is to allow its dividend to grow at 5% for the first four years and then the
rate of growth changes to 3% per year from year 5 and so on. What is the value of
the ordinary share if the required rate of return is 8%?
P1 = PV up to year 4. (Variation)
t Dividend (Dt) PVIF 8%, t PV
1 RM1.5750 0.9259 RM1.4583

i
D0 (1+g) [1.5 x 1.05]
2 RM1.6538 0.8573 RM1.4178
D1(1+g) [1.5750 x 1.05]
3 RM1.7365 0.7938 RM1.3784
D2(1+g) [1.6538 x 1.05]
4 RM1.8233 0.7350 RM1.3401
D3(1+g) [1.7365 x 1.05]

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Updated: Sept23 PV PERIOD 1 (P1) = RM5.5946
3.3- Differential Growth Model (Cont’d)
EXAMPLE (Cont’d)
P2 = PV from beginning of year 5 or end of yr 4 to perpetuity. (Grow at constant rate)

Expected Div. in year 5, D5 = 1.8233 (1 + 0.03) = RM1.8780 t

dividend growth
PV PERIOD 2 (P2) = 1.8780/(0.08-0.03) x 0.7350 Rit2

↓ ↓
Price beginning of year 5 or
constant
end of year 4 zerwith growth
(Expected Price in year 5) g
= RM37.56 x 0.7350 POL 1> -

ke -

y
+Prit
-
= RM27.6066
Intrinsic Value of share = P1 + P2
= RM5.5946 + RM27.6066
= RM33.20

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Updated: Sept23
REFERENCE:
Mohd Nizal Haniff, Norli Ali, Norashikin Ismail, Noreena Md Yusoff. Introduction to
Malaysian Financial Markets (2024). Mc Graw Hill. Revised First Edition.

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Updated: Sept23