The Investor and Share Valuation

Abstract

An investor with a building society savings account knows precisely the rate of interest receivable on his or her savings and can make direct comparisons with current returns on alternative ‘safe’ investments. She is not concerned about the underlying or future earnings of the building society. By comparison, an investor in ordinary shares has to forecast the future returns from his or her investment. She normally expects to receive a continuing, fairly stable but growing annual dividend and a progressive increase in the value of the shares. She should therefore subject proposed investments to the same principles of appraisal as those applied to businesses and dealt with in Chapter 3. Theoretically the current market value of the shares should represent the present value of future dividends, plus the expected proceeds of their sale some time in the future. But, as these cash flows are the product of company investment projects, it follows that share values represent the present value of future cash flows from these projects. We discuss share valuation in more detail later in this chapter.