Question

Several factors, both internal and external, impact a company's stock price and the subsequent perceived valuation of a company. Sometimes that perceived value matches that of the financial statements, and other times it is vastly different. Therefore, discuss the factors that lead to a valuation of a company's worth compared to that of the financial statements and how company executives create the most value for all stakeholders. note: about 300 words will be enough

Answer 1

The valuation of company based on its share price gives us the Market Capitalization of the company. It is essentially a product of two variables i.e Share Price and Shares Outstanding.

Shares Outstanding being a fixed number, the company valuation gets impacted by change in stock Price which in turn gets impacted by many internal and external factors:

Company Specific Factors:

• Quarterly or Annual earnings Release
• Company Management - Part of shareholder value comes from investor confidence in management.
• Mergers / Acquisitions
• Shares can dip in case an Accounting Error or Scandals is reported
• Investor belief and confidence in the company and its ideas – Eg. Promising New Product
• News of a product recall

External Factors affecting Share Price:

• Investor Sentiments – Bull / Bear Market
• Regulation and Competition
• Economic and Political trends

Basically, market view of the company is reflected in Market Capitalisation. However, it does not take into consideration the different capital structures. Hence, Enterprise Value can be calculated and when used in conjunction with EBIT, EBITDA, Revenue and other metrics, it can provide key insights and comparisons between two companies with even a large difference in capital structure.

Enterprise Value = Market Cap + Market value of preferred shares + Total debt+ minority interest – Cash and Cash Equivalents

The Executives play a key role in creating shareholder value as they are the decision makers in the company and they should :

• Make strategic decisions that maximize long term expected value, even at the expense of lowering near-term earnings.
• Ensure expected long term returns are greater than the cost of capital
• Make timely acquisition suitable for companys growth
• Ensure a steady cash flow in the long term
• Return cash to shareholders when there are no credible value-creating opportunities to invest in the business.