Question

List and briefly discuss the three special cases in which we can come up with a value for a share of stock.

Answer 1

1. Yield basis method - Yield is the effective rate of return on investments which is invested by the investors. It is always expressed in terms of percentage. Since the valuation of shares is made on the basis of Yield, it is called Yield-Basis Method. For example, an investor purchases one share of Rs. 100 (face value and paid-up value) at Rs. 150 from a Stock Exchange on which he receives a return (dividend) @ 20%.

2. Return on capital employed method -

Under this method, valuation of share is made on the basis of rate of a return (after tax) on capital employed. Rates of return are taken on the basis of predetermined/expected rates of return which an investor may expect on the investments. After ascertaining this expected earnings, we are to determine the capital sum for such a return.

Thus, we are to follow the following procedure one by one:

(a) Ascertain the expected (maintainable) profit (after adjustments, if any);

(b) Ascertain the normal rate of return on capital employed for a similar business;

(c) At last, on the basis of expected rate of return, capitalize the (maintainable) profit.

3. Price to earnings ratio method -

We know that it is the ratio which relates the market price of the share to earning per equity share.

It is calculated as: