How to determine the value of a company’s share

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

20 July 2008

Daniel Kungu is direct and to the point when he says, “Tell me in a layman's language: How does a calculator work? What’s a share? How do you workout the number of shares and their value in a given business or company? Must a plane run before takeoff? Can’t they be made to takeoff like the choppers and save on the runway costs? How do the engines work? What makes one country's currency valuable than the other? When were the countries boundaries drawn and named?

I will start with the easier questions and leave the others for another day: A share in a company is exactly that: It is a share (or a portion) of the company. The number of shares is determined by the owners and there is no restriction on how many there can be. What matters is the value attached to each share.

For example, there can be a company worth one million shillings that is divided into one million shares of one shilling each. Another one can be worth the same amount but be divided into two shares of Sh500,000 each. The two will be exactly the same in terms of value. Having more shares does not necessarily mean that the business is worth more.

But this is at inception. After the company starts operating, the value of its shares will depend on how successful the business is. If it is profitable, their value (strictly speaking, “book value”) will increase and if it makes losses they will become less valuable.

The book value is simply the net assets (what the company owns minus what it owes) divided by the number of shares. It is also known as the net asset value (NAV). This can be very different from the market value which is the amount of money other people would be willing to pay for the shares.

Some companies’ market value is greater than the book value while in others it is less. It all depends on the nature of the business that the company conducts and also on the forces of supply and demand.

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Yes: an aeroplane must run before take-off. It is much easier to propel an object horizontally than vertically upwards. The shapes of the wings of an aircraft cause air to move at different speeds (above and below) thereby creating a pressure difference which, in turn, lifts the whole plane from the ground.

For that to happen, the plane must move very fast horizontally – hence the need for a runway. However, vertical lift and landing (VTOL) aeroplanes have been designed but they consume too much fuel during the lift.

The fixed cost of building a runway is much less than that of the additional fuel required for vertical lift. For this reason, VTOLs are only widely used by the military.