True value of a share?

If you were to buy the entire company, how much will you pay?

If there are 10 lac shares of the company and each share is available @50/-, you can walk away with the company if you pay value of the entire 10 lac shares i.e. 500 lacs or 5 crore.

But if you don't know the share price or if you don't trust the share price or if the company is not a listed one, how much should you pay?

In such a case you need to find out the true value of the company by alternative methods.

One obvious way is to find out the net worth of the company.

Net worth = Assets - Liabilities = Net assets

But many a times this can give you very wrong picture.

For example, there is a decades-old super-famous Chane-bhaturewala shop on the mall road in Shimla.

It daily downs the shutter at 4 pm. Irrespective of how much stuff is prepared in the morning everything is sold out by around 4. (I must myself admit that they make damn tastiest Chane-bhature!)

If you were to buy out his business and go by the above formula of net worth, you may commit the mistake of offering him the cost of his shop minus whatsoever liabilities he has (by the way, he has none!)

He will fry you in his Bhatura vessel!!!

Why?

Because he daily sells Chana bhatura worth approx. 11000 and his shop's value in municipal corporation's accounts book is just 2 lacs! Putting the networth of this shop at just 2.33 lacs!

Therefore, as in this case, it may be grossly wrong to judge the value of a company by its net worth.

So, how do we find the fair value of a company?

Another way is the cash flow way!

This chana bhatura shop is generating an annual cashflow of 3years x 11000 per day x 365days days = 1 crore 20 lacs!

So according to a formula, the minimum price of his business (and not shop, mind you)
= (Potential profits for 3 years) + Assets and Inventories

Assuming a net profit margin of 50% in chana Bhatura, this gentleman's empire will be valued at

= 50% of 1crore20lacs + book value of shop

= 60 lacs + 2 lacs

=62 lacs

Now, would you be surprised if I told you that this gentleman's shrewd son is demanding 80 lacs as "pagri" from the potential buyers!

And would you be surprised if I told you that some businessmen are already willing to pay as much as 45 lacs! (The negotiation was going on till the writing of this article!)

But why is the son of the chana bhatura king asking for 80lacs and not 62lacs?

In his words "People come here in 'our' name!!! We have been serving mouth watering chana bhaturas since 60 years! we have a reputation and a pull value! We have a brand equity. 18 lacs is just for that. You can expand the business with that name!"

What if the potential buyer says

"We don't want to keep your name. Reduce the price now by 18 lacs" ?

And what if the equally-shrewd son of the bhatura-empire replied

"Ok, we will reduce the price by 18 lacs. But i hope you will not mind if we open another Chana bhatura shop in the neighbourhood in our name!!!"

-------------------

Now if I told you that this Chana bhaturawala floats 10,000 shares what will be the fair market value of each share?

= (Market value of the company as decided above i.e. 80 lacs) divided by (1000 shares)

= 800/- per share

-------------------

If this company was making software instead of chana Bhaturas and had a huge future value, that value would have been added to the share value!

-------------------

Now, what will be the value of this company if its current owners decide to start giving franchisees under their brand name in all Tier-II and tier-III cities along with their secret recipe !!!