The valuation of shares may be done by an accountant for two reasons :
(i) where there is no market price as in the case of a proprietary company.
(ii) where for special reasons, the market price does not reflect the true or intrinsic value of the shares.
The problem does not arise if the shares are quoted on the stock exchange as it provides a ready means of ascertaining the value placed on such shares by the buyers and sellers.
Need for Valuation
The following are the circumstances where need for valuation of shares arises :
(i) Where companies amalgamate or are similarly reconstructed, it may be necessary to arrive at the value of the shares held by the members of the company being absorbed or taken over. This may also be necessary to protect the rights of dissenting shareholders under the provisions of the Companies Act, 1956.
(ii) Where shares are held by the partners jointly in a company and dissolution of the firm takes place, it becomes necessary to value the shares for proper distribution of the partnership property among the partners.
(iii) Where a portion of the shares is to be given by a member of proprietary company to another member as the member cannot sell it in the open market, it becomes necessary to certify the fair price of these shares by an auditor or accountant.
(iv) When a loan is advanced on the security of shares, it becomes necessary to know the value of shares on the basis of which loan has been advanced.
(v) When preference shares or debentures are converted into equity shares, it becomes necessary to value the equity shares for ascertaining the number of equity shares required to be issued for debentures or preference shares which are to be converted.
(vi) When equity shareholders are to be compensated on the acquisition of their shares by the Government under a scheme of nationalization, then it becomes necessary to value the equity shares for reasonable compensation to be given to their holders.
Factors Affecting Valuation of Shares
Valuation of shares depends upon the purpose of valuation, the nature of the business of the company concerned, demand and supply for shares, the government policy, past performance of the company, growth prospects of the company, the management of the company, the economic climate, accumulated reserves of the company, prospects of bonus or rights issue, dividend declared by the directors and many other related factors.
The basic factor (or principle) in the valuation of shares is the dividend yield that the investor expects to get as compared to the normal rate prevailing in the market in the same industry. For small investors, rate of dividend declared by the directors plays an important role in the valuation of shares whereas investors holding bulk of shares (say 15% to 30%) would be able to affect the dividend rate, therefore for them total profits (or earning capacity) play an important part in the valuation of shares. Thus, for a bulk holders of shares net assets including goodwill or capitalized value on the basis of the expected profits may be basis of valuation of shares.
Methods of Valuation
The different methods of valuing shares may be broadly classified as follows :
1. Net Assets Basis (or Intrinsic Value or Break up Value) Method.
2. Earning Capacity (or Yield Basis or Market Value) Method.
3. Dual (or Fair Value) Method.
(1) Net Assets Basis
This method is concerned with the assets backing per share and may be based either :
(a) on the view that the company is a going concern.
(b) on the fact that the company is being liquidated.
(a) Company as a going concern. If this view is accepted, there arc two approaches ;
(i) To value the shares on the net tangible assets basis (excluding the goodwill).
(ii) To value the shares on the net tangible assets plus an amount for goodwill.
(i) Net Tangible Assets Basis (Excluding the Goodwill)
Under this method, it is necessary to estimate net tangible assets of the company (Net Tangible Assets = Assets – Liabilities) in order to value the shares, In valuing the figures by this method, care must be exercised to ensure that the figures representing the assets arc sound, i.e., intangible assets and preliminary expenses are eliminated and all liabilities (whether in books or not) are deducted from the value of the tangible assets. Non-trading assets are also included in the assets and the assets are taken at their market value, i.e., replacement value.
Where both types of shares are issued by a company, the shares would be valued as under:
(1) If preference shares have priority as to capital and dividend, then the preference shares are to be valued at par.
(2) After the preference shareholders are paid the net tangible assets are to be divided by the number of equity shares to calculate the value of each share. If at the time of valuation there is an uncalled capital, then the uncalled equity share capital be added with the net tangible assets in order to value the shares fully paid up. The valuation of shares for the shareholders who have calls on arrears will be valued as a percentage on their paid up value with the nominal value of shares. If the company has equity shares of varying face value, the total replacement value of assets left after deducting the paid up. value of preference shares is first apportioned to different categories of equity shares on the basis of paid up value of such categories. The amount thus arrived at would be divided by the number of shares in each of such categories to get the value of each share of such categories.
(3) If the preference shares are participating and rank equally with the equity shares, then the value per share would be in proportion to the paid up value of preference shares and equity shares.