2. Valuation
You should take some time to get comfortable with the basic principles of corporate valuation, a term that refers to the economic appraisal of a businesses. That is what a project promotor or an investor should and will be looking at: the gains to be harvested through their entrepreneurship venture.
What is value?
Firstly, lets state what is value: it can be assumed as the price that a person has pays for a given product, service or asset. As in products or services, financial assets are valued by the benefit that individuals and organizations believe they can obtain through assets. A company’s share is no different and its value is dependent of the expectations of a potential selling part and of a potential acquiring part. That means that a share may have a 1$ of nominal value, but it can be sold at any amount as long as there is a seller willing to receive that amount and buyer willing to pay it.
At this point it is important to distinguish:
- Issued capital (or share capital) nominal value: corresponds to the total nominal value of the shares issued by a company. The ownership share capital grants its holders the right to the nominal value of the share and to the economic benefits of holding the equity of the company.
- (Market) Equity value: corresponds to the value of the economic benefits of holding the issued capital.
Equity value is obtained by multiplying the number of shares by the share price.
Example – Calculating Equity value
The following table presents the number of shares, its nominal value and price.
| Company | A | B | C | D | E |
| Shares | 3.500.000 | 500.000 | 65.000.000 | 1.000.000.000 | 8.564.000 |
| Nominal value | 1,00 | 1,00 | 1,00 | 0,50 | 1,00 |
| Price | 14,37 | 9,04 | 1,31 | 0,71 | 3,62 |
The resulting issued capital and equity value are:
| Company | A | B | C | D | E |
| Issued capital | 3.500.000 | 500.000 | 65.000.000 | 500.000.000 | 8.564.000 |
| Equity value | 50.295.000 | 4.520.000 | 85.150.000 | 710.000.000 | 31.001.680 |
Publicly traded companies shares value can be easily identified in stock markets as the prices are public. Because every day a large volume (number) of stocks is traded, the public prices are quite a good insight for what most investors believe the company is worth.
Knowing the value of the shares of non-publicly traded companies is somewhat more difficult and it implies using one or more valuation approaches and methods.
Example – Issued capital, Equity and Equity value
Company Yummi Tasty Mega Burger’s issued capital is composed of 50.000.000 shares, each with a nominal value of 0,50€. The company is publicly traded and is currently being traded at a value of 1,25€ per share.
The nominal value of the shares is 25.000.000€.
Through a quick check on the balance sheet, you will identify that the Equity corresponds to 45.600.000€
But its Equity value (the value at which the shares are being traded) is different:
The difference between Equity and the Equity value results from the valuation of the economic benefits investors believe the company may bring them.
Example – Difference between Equity and Equity value
To illustrate that in the real world the equity value is different from (the accounting) equity, you can observe in the following graph the market cap of Microsoft corporation in 2016. You can notice that the Equity value of Microsoft’s shares ranged between approximately 380 billion dollars and 485 billion dollars in 2016. But the company’s equity (as registered in the books) at 2015 year’s close was approximately 80 billion dollars and the year close of 2016 a bit under 72 billion dollars.
Equity value is not always above of equity and in certain cases, investors may value a company’s equity under the equity that is stated on the balance sheet.
Remember: Issued capital is different from the equity, which is itself different from the Equity value. For disambiguation purposes and strict use of nomenclatures (within CASFLO APP) keep the following:
- Issued capital: sum of total share by its nominal price. It is capital invested by the equity holders.
- Equity: corresponds to the book-value (accounting view) of equity and is obtained by the sum of the equity items within the balance sheet.
- Equity value (or equity market value): it is the value that the holders of the shares and potential acquires would be willing to accept (for selling) or paying (to acquire) those shares. Since the estimated economic benefits that economic agents recognize a share may bring them is most of the times different from the book-value of the company, equity value is commonly different from the equity (book-value).
Next Section: 2.1. Valuation methods