Page 154 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Unit 5: Equity Valuation Models

5.1 Balance Sheet Valuation Notes

The objective of balance sheet valuation is the calculation of material prices for subsequent use
in external or internal balance sheets, typically for valuation of the stocks of current assets.

Generally, the conditions include meeting legal requirements, complying with corporate group
guidelines, and implementing internal company objectives regarding accounting policy. In this
context, the company code is regarded as an independent accounting unit.
1. Book Value: To clearly distinguish the market price of shares from the core ownership
equity or shareholders' equity, the term 'book value' is often used since it focuses on the
values that have been added and subtracted in the accounting books of a business
(assets - liabilities). The term is also used to distinguish between the market price of any
asset and its accounting value which depends more on historical cost and depreciation. It
may be used interchangeably with carrying value. While it can be used to refer to the
business' total equity, it is most often used:
(a) as a 'per share value': The balance sheet Equity value is divided by the number of
shares outstanding at the date of the balance sheet (not the average o/s in the
period).
(b) as a 'diluted per share value': The Equity is bumped up by the exercise price of the
options, warrants or preferred shares. Then it is divided by the number of shares
that has been increased by those added.
Uses
Book value is used in the financial ratio price/book. It is a valuation metric that sets the
floor for stock prices under a worst-case scenario.

Notes When a business is liquidated, the book value is what may be left over for the
owners after all the debts are paid.

Paying only a price/book = 1 means the investor will get all his investment back, assuming
assets can be resold at their book value. Shares of capital intensive industries trade at
lower price/book ratios because they generate lower earnings per dollar of assets. Business
depending on human capital will generate higher earnings per dollar of assets, so will
trade at higher price/book ratios.
Book value per share can be used to generate a measure of comprehensive earnings, when
the opening and closing values are reconciled. Book Value Per Share, beginning of year -
Dividends + Share Issue Premium + Comprehensive EPS = Book Value Per Share, end of
year.

Changes are caused by
(a) The sale of shares/units by the business increases the total book value. Book value
per share will increase if the additional shares are issued at a price higher than the
pre-existing book value per share.
(b) The purchase of its own shares by the business will decrease total book value. Book
value per share will decrease if more is paid for them than was received when
originally issued (pre-existing book value per share).
(c) Dividends paid out will decrease book value and book value per share.

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