Stock Valuation

286 PART 2 Important Financial Concepts
book value per share
The amount per share of common
stock that would be received if all
of the firm’s assets were sold for
their exact book (accounting)
value and the proceeds remaining
after paying all liabilities (including
preferred stock) were divided
among the common stockholders.
liquidation value per share
The actual amount per share
of common stock that would
be received if all of the firm’s
assets were sold for their market
value, liabilities (including
preferred stock) were paid, and
any remaining money were
divided among the common
stockholders.
stock that the firm has outstanding, we get a common stock value of
$15.76 per share ($4,728,620300,000).
It should now be clear that the free cash flow valuation model is consistent
with the dividend valuation models presented earlier. The appeal of this approach
is its focus on the free cash flow estimates rather than on forecast dividends, which
are far more difficult to estimate, given that they are paid at the discretion of the
firm’s board. The more general nature of the free cash flow model is responsible
for its growing popularity, particularly with CFOs and other financial managers.
Other Approaches to Common Stock Valuation
Many other approaches to common stock valuation exist. The more popular
approaches include book value, liquidation value, and some type of price/earnings
multiple.
Book Value
Book value per share is simply the amount per share of common stock that
would be received if all of the firm’s assets were sold for their exact book
(accounting) value and the proceeds remaining after paying all liabilities (including
preferred stock) were divided among the common stockholders. This method
lacks sophistication and can be criticized on the basis of its reliance on historical
balance sheet data. It ignores the firm’s expected earnings potential and generally
lacks any true relationship to the firm’s value in the marketplace. Let us look at
an example.
EXAMPLE At year-end 2003, Lamar Company’s balance sheet shows total assets of $6 million,
total liabilities (including preferred stock) of $4.5 million, and 100,000
shares of common stock outstanding. Its book value per share therefore would be
$
1 5 $6,000,000$4,500,000
per share
100,000 shares
Because this value assumes that assets could be sold for their book value, it may
not represent the minimum price at which shares are valued in the marketplace.
As a matter of fact, although most stocks sell above book value, it is not unusual
to find stocks selling below book value when investors believe either that assets
are overvalued or that the firm’s liabilities are understated.
Liquidation Value
Liquidation value per share is the actual amount per share of common stock that
would be received if all of the firm’s assets were sold for their market value, liabilities
(including preferred stock) were paid, and any remaining money were divided
among the common stockholders. 5 This measure is more realistic than book
5. In the event of liquidation, creditors’ claims must be satisfied first, then those of the preferred stockholders.
Anything left goes to common stockholders.