A complete summary of Chapter 9: Share Valuation from the Corporate Finance textbook assigned to the module. This includes outlines from the slides as well.
Shares are a subdivision making up a portion of a company’s capital. Shares
represent an investors’ portion of the productive assets of a business.
The Development of Stock Exchanges Globally
The first ‘stock exchange’ in Europe was established by the French Kind Phillip the
Fair in the 12th century to facilitate credit transactions. The London Stock Exchange
(LSE) opened in 1773, and the first stock exchanges in the US were established in
Philadelphia in 1791, and in New York in 1792.
The Johannesburg Stock Exchange (JSE) was established in 1887, one year after
gold was found in the Witwatersrand. After more than a century of operating an open
outcry trading system (verbal), the JSE replaced it with an order-driven, centralized,
automated trading system.
By the end of 2013, there were 53 regulated stock exchanges around the world.
Ordinary Shares and Preference Shares
Listed companies can issue different types of shares to raise capital from the public.
Ordinary and preference shares are the most common shares used.
Ordinary shareholders are not guaranteed dividends but do have the right to vote at
annual general meetings (AGMs). Ordinary shareholders also have the pre-emptive
right to purchase additional shares in the company in the future.
B-ordinary shares are a second class of ordinary shares that can be listed and
traded. B-ordinary shares have fewer or no voting rights and may not have the right
to any capital should the company be dissolved. These shares are best suited for
investors seeking long-term investments and those willing to accept higher risk to
achieve higher return.
Preference shareholders have no voting rights at AGMs (except under certain
circumstances), but they do receive preferential treatment when it comes to the
distribution of profits and assets in the event of liquidation. Preference shares
normally offer a fixed annual dividend rate, and combinations of variable and fixed
payment have been used in recent years.
There are five types of preference shares:
Cumulative
With cumulative preference shares, any dividends that have not been paid in a
particular period will accumulate over time. Shareholders therefore remain entitled to
these dividends.
Non-Cumulative
These shares do not entitle shareholders to dividends not paid in previous periods.
The company is not liable to pay any missed dividends.
, Participating
These shares allow shareholders to receive a higher dividend if the company
performs better than expected. These dividends will have a lower limit but no upper
limit.
Convertible
Convertible shareholders are allowed to convert their shares into a predetermined
number of ordinary shares at a specified date.
Redeemable
Redeemable shares can be called back by the issuing company at a stated maturity
date. Shareholders will receive the par value at which the shares were issued plus a
dividend.
Defining Share Value
Given the importance that shareholders and stakeholders attach to the value and
valuation of shares, there are four different definitions of value that can be used: par
value, market value, book value and intrinsic value.
Par Value
The par value of a share is the value at which the share is issued in the primary
market. This value will be indicated on a firm’s statement of financial position.
Market Value
The market value is the current price of a share, and this is determined by the forces
of demand and supply in the secondary market. The total market value of a share on
a particular date can be determined by multiplying the market price per share on that
date with the number of ordinary shares issued.
Book Value
The market value of a company’s shares is usually very different to its book value.
The book value is what a company would have left over if all its assets were to be
sold for their book values, and all liabilities were to be paid.
BV of ordinary shares
BV per share=
¿ of issued ordinary shares outstanding
If the market value > book value, management has created value for the company’s
shareholders.
Intrinsic Value (Economic Value)
This value is often used by prospective investors when evaluating investment
opportunities.
If intrinsic value > market value, then the share is undervalued and should be
bought.
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