Whenever people talk about equity investments, one must have come across the word “Valuation”. In financial parlance, Valuation means how much a company is worth of. Talking about equity investments, one should have an understanding of valuation.
Valuation means the intrinsic worth of the company. There are various methods through which one can measure the intrinsic worth of a company. This section is aimed at providing a basic understanding of these methods of valuation. They are mentioned below:
Net Asset Value (NAV)
NAV or Book value is one of the most commonly used methods of valuation. As the name suggests, it is the net value of all the assets of the company. If you divide it by the number of outstanding shares, you get the NAV per share.
One way to calculate NAV is to divide the net worth of the company by the total number of oooutstanding shares. Say, a company’s share capital is Rs. 100 crores (10 crores shares of Rs. 10 each) and its reserves and surplus is another Rs. 100 crores. Net worth of the company would be Rs. 200 crores (equity and reserves) and NAV would be Rs. 20 per share (Rs. 200 crores divided by 10 crores outstanding shares).
NAV can also be calculated by adding all the assets and subtracting all the outside liabilities from them. This will again boil down to net worth only. One can use any of the two methods to find out NAV.
One can compare the NAV with the going market price while taking investment decisions.
Discounted Cash Flows Method (DCF)
DCF is the most widely used technique to value a company. It takes into consideration the cash flows arising to the company and also the time value of money. That’s why, it is so popular. What actually happens in this is, the cash flows are calculated for a particular period of time (the time period is fixed taking into consideration various factors). These cash flows are discounted to the present at the cost of capital of the company. These discounted cash flows are then divided by the total number of outstanding shares to get the intrinsic worth per share.