5: Valuing Shares

SUMMARY

■ Preferred shares have both debt- and equity-

like features, and do not usually represent an

ownership position in the company.

■ Ordinary shares represent a residual claim

on a company’s cash flows, and ordinary

shareholders have the right to vote on

corporate matters.

■ The same principles apply to the valuation of

preferred and ordinary shares. The value of a

share depends on the cash flow the share is

expected to pay its owner over time.

■ Because preferred shares pay a constant

dividend with no specific expiration date,

they can be valued using the perpetuity

formula from Chapter 3.

■ The approach used to value ordinary shares

depends on investors’ expectations of

dividend growth. Zero dividend growth,

constant dividend growth and variable

dividend growth can all be incorporated into

the basic valuation approach.

■ Estimating dividend growth is very difficult. A

starting point is to multiply the retention rate

times the return on equity.

■ Analysts use the free cash flow approach to

value the entire enterprise. From that, they

derive a price per share.

■ Other approaches to valuation rely on book

value, liquidation value or valuation multiples

of comparable companies.

■ Share markets can be classified as either

primary or secondary. Shares are sold for

the first time in the primary market, but after

that, trading occurs in the secondary market.

■ Investment bankers play an important role in

helping companies issue new securities.

■ Shares for listed companies trade in Australia

on the Australian Securities Exchange (ASX)

and on Chi-X Australia.

LO5.1

LO5.2

IMPoRtANt EQUAtIoNS

5.1 PS=

D

r

p

p

0

5.2 =

+

+

P

DP

(1 r)

0

11

1

5.4 =

−

P

D

(^0) rg
1
5.5

• 
  


• 
  


• 
  


• 
  


• 
  


• 
  


• 
  


• 
  


• 
  


• 
  

  ×
  −
  
  
  
  
  
  
  P Dg +
  r
  Dg
  r
  Dg
  rr
  D
  rg
  (1 )
  (1 )
  (1 )
  (1 )
  ...
  (1 )
  (1 )
  1
  (1 )
  N
  NN
  N
  0
  01
  1
  1
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  2
  2
  01 1
  2
  PV of dividends during initial
  growth phase
  PV of all dividends
  beyond the initial
  growth phase
  5.6 g = rr × ROE
  5.7 Vshares = Vcompany – Vdebt – Vpreferred
  LO5.3
  LO5.5
  LO5.6
  LO5.4