How to Calculate Share Price?

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Share Prices and the Market

 Ordinarily, supply and demand drive the stock market in the same manner that they propel forward other markets. Each time a stock is sold, its buyer and seller swap money for share ownership. The new market price is the price at which the stock is bought for. As and when more stocks sell, their selling prices become the newest market prices. 

 The Influence Demand and Supply Has on Share Prices

 The greater the demand there is for a stock, the more intensity with which its price rises. Similarly, in the event that the demand for a stock is lacklustre at best and it continues to dip, so too, does its price. 

 Now, the quantity of a stock also drives its price. Should a stock be limited in its quantity, its price is likely to rise upward whereas if there are ample amounts of a stock available, its price is likely to move downwards. 

 This means that while, theoretically speaking, a stock’s initial public offering or IPO is offered at a price that equals the value of its future dividend payments, its price still fluctuates keeping in mind supply and demand.

 Understanding Factors That Affect Share Prices Directly

 In addition to demand and supply, the following factors directly impact share prices.

 The earnings and profitability of a company via their production and sale of goods and services.

The behavioural factors of investors and traders operating the market can cause stock prices to move.

In the event that supply and demand are equal, stability prevails within a company’s share prices and they experience only a minor increase or decrease in their prices. In the event that the supply or demand suddenly outweighs the other, an abrupt price change can be expected.In instances of a company issues new shares in the market to be purchased by the public, the quantity offered is ordinarily limited. In the event that tons of investors seek to get their hands on these shares and the supply remains limited, the share prices will rise.

In case a company chooses to buy back its shares from the market, it reduces the number of shares that circulate within the market. With the reduced supply now available, the prices of the company’s shares can rise.

 Understanding Factors That Affect Share Prices Indirectly

 Listed below are some of the factors that indirectly influence the prices of company stocks.

• Changes made to economic policies
• Deflation
• Global fluctuations
• Industry trades
• Inflation 
• Interest Rates
• Market sentiment 
• Natural disasters

 Company Share Price and Company Value

 While the law of supply and demand is fairly straightforward to understand, understanding demand in real time can be tricky. Investors’ feelings towards a company’s worth are showcased in the price movement of a stock. However, how do investors decide what a company is worth? One area they definitely do take into account is said company’s current earnings i.e., the extent to which and how much profit it accrues. Yet most investors do tend to look beyond these numbers as well. This means that the price of a stock isn’t exclusively reflective of its company’s prevailing value. It also indicates the company’s prospects and the growth the investors believe – or rather, expect – it to achieve in the future. 

 Predicting a Company’s Share Price

 Quantitative techniques and formulas are utilised in order to predict what a company’s share prices will amount to. These models are called dividend discount models (or DDMs) and are created keeping in mind the idea that a stock’s current price is equivalent to the sum total of each of its dividend payments made in the future when discounted back to their current value. By discerning a company’s share by its anticipated future dividends in their totality, dividend discount models actively employ the time value of money (or TVM) theory.

 The Gordon Growth Model

 While there exist plenty of dividend discount models, some are more popular than others. The Gordon Growth Model, for instance, is popular owing to its inherent straightforwardness. Myron Gordon, an American economist is credited with developing this model in the 1960s.

 The present value of stock is equal to dividend per share divided by the discount rate from which the growth rate has been subtracted. 

 The equation that the Gordon Growth Model employs is represented as follows. 

  P = D1  / r – g

 Here, 

P = current stock price

g = constant growth rate in perpetuity anticipated for the dividends of the stock

r = constant cost of equity capital for said company (this is also referred to as the rate of return)

D1 = value of the following year’s dividends

 Using an Example to Understand Share Price Valuation 

 Let us assume that company ABC’s stock is trading at INR 100 per share. Now, this company requires a 5 % rate of return (r) as its minimum and presently pays INR 2 dividend per share (D1). This figure is expected to rise by 3 per cent on an annual basis (g).

 The intrinsic value (p) of the stock can therefore be calculated as follows. 

 INR 2 / (0.05 – 0.03) = INR 100

 As per the Gordon Growth Model, since these shares prices’ match their intrinsic value, they are correctly valued and appropriately price. If, however, they were being traded at a price of INR 150 per share, they would be overvalued by 50 per cent. Similarly, if they were being traded at a price of INR 80 per share, they would be undervalued by INR 20. If this undervalued price prevailed, it would create a buying opportunity for value investors that actively seek out stocks that are operating below their intrinsic value as it gives them a chance to score a profit in the future.

 The Gordon Growth model considers a stock’s current value in the same way it would treat perpetuity, which here means a constant stream of the same cash flows for an unending period of time. However, in real life companies do not and are not able to maintain the same rate of growth each year and their stock dividends aren’t necessarily going to increase at a constant rate. 

 Further, while a stock price is conceptually decided keeping in mind its anticipated future dividends, it is important to understand that several companies do not distribute dividends.

 Conclusion

 Those seeking to make profits from the stock market often look out for shares whose market prices fall below their intrinsic value. Investors who purchase these shares frequently are called value investors and they aim to hold onto these shares for a significant period of time or until the market price equals if not exceeds their intrinsic value such that they can generate returns on their investments. Methods used by value investors to discern which stocks operate below their intrinsic value include the following.

Price to earnings (or P/E) ratio 

Price to book (P/B) ratio

Debt to equity (D/E) ratio

Free Cash Flow

Price/ earnings to growth (or PEG) ratio