Special Factors for Valuation of Shares :
Valuation of equity shares must take note of special features in the company or in the particular case. These are briefly stated below:
(a) Importance of the size of the block of shares: Valuations of the identical shares of a company may vary quite significantly at the same point of time on a consideration of the size of the block of shares under negotiation. It is common knowledge that the holder of 75% of the voting power in a company can alter even the provisions of the articles of association to suit himself; a holder of voting power exceeding 50% and less than 75% can substantially influence the operations of the company even to alter the articles of association or comfortably pass a special resolution.
Even persons holding less than 50% of the total voting strength in a public limited company may control the affairs of the company, if the shares carrying the rest of the voting power are widely scattered; such shareholders rarely combine to defeat a determined block. Usually a person holding 10 to 15% of the total voting power is in a position to have his way in the company – even to change the provisions of the articles of association or pass any special resolution.
The above analysis is associated with the concept of the controlling interest, which according to most authorities carries a separate value to the tune of additional 10 to 20% of the value of shares otherwise obtained.
(b) Restricted transferability: Along with principal considerations of yield and safety of capital, another important factor is the easy exchangeability or liquidity. Shares of reputed companies generally enjoy the advantage of easy marketability which is of great significance to the holder. At the time of need, he may get cash in exchange of shares without being required to hunt out a willing buyer, or without being required to go through a process of long negotiation and valuation. Generally quoted shares of good companies are preferred for the purpose. On the other hand, holders of shares of unquoted public companies or of private companies do not enjoy this advantage; therefore, such shares, however good, are discounted for lack of liquidity at rates which may be determined on the basis of circumstances of each case. The discount may be either in the form of a reduction in the value otherwise determined or an increase in the normal rate of return. Generally, the articles of private companies contain provisions for offering shares to one who is already a member of the company and this necessarily restricts the ready market for the shares. These shares are also discounted for limited transferability. But exceptions are also there; by acquisition of a small block, if one can extend his holding in the company to such an extent as to effectively control the company, the share values may not be depressed in that deal.
(c) Dividends and valuation: Generally companies paying dividends at steady rates enjoy greater popularity and the prices of their shares are high while shares of companies with unstable dividends do not enjoy confidence of the investing public as to the returns they expect to get and consequently they suffer in valuation. For companies paying dividends at unsteady rates, the question of risk also becomes great and it depresses the price. The question of risk may be looked upon from another angle. A company which pays only a small proportion of its profit as dividend and thus builds up reserves is less risky than the one which has a high pay out ratio. The dividend rate is also likely to fluctuate in the latter case. Investors, however, do not like a company whose pay-out ratio is too small.
Shares are generally quoted high immediately before the declaration of dividend if the dividend prospect is good; or immediately after the declaration of dividend (if it is satisfactory) to take care of the dividend money that the prospective holder would get.
(d) Bonus and right issues: Share values have been noticed to go up when bonus or right issues are announced, since they indicate an immediate prospect of gain to the holder although, in the ultimate analysis, it is doubtful whether really these can alter the valuation. Bonus issues are made out of the accumulated reserves in the employment of the business, which in no way contribute to the increased earning capacity of the business and ultimately depress the dividend rate since the same quantum of profit would be distributed over a larger number of shares, which in turn also would depress the market value of the shares. However, a progressive company generally picks up the old rate of dividend after a short while but this is no way a result of bonus issue; it is the contribution of growth potential of the company.
However, in the case of right issues, the existing holders are offered the shares forming part of the new issue;more funds flows into the company for improving the earning capacity. Share values will naturally depend on the effectiveness with which new funds will be used.