In order to answer the question; ‘how do we measure shareholders’ wealth?’ We have to first of all understand the sources of shareholders’ wealth.
There are two primary sources of shareholders wealth namely:
1. Dividends received from investment
2. Market value of share or through capital appreciation
In financial management terms, we call this the Total Shareholder Return (TSR). TSR = dividend yield + capital gains through share price appreciation.
For us to measure shareholders wealth, we must first of all have an idea of what the value of a company is and what its shares are worth. This process sound very easy in theory but is very difficult or impossible in practice to correctly ascertain the value of a company and its shares.
At best, we can employ some valuation techniques which we shall briefly look at to value a business and its share.
How to value a company
We will discuss 3 most popular business valuation techniques in this section of this article that attempts to provide an answer to the question ‘how do we measure shareholders’ wealth?’
1. Valuation through analysing statement of financial position (AKA Balance Sheet)
Here, analysts value a company based on the worth of a company’s assets on a going concern basis. A company’s statement of financial position value increases as company retains its earnings. If this increase is maintained year on year it then means that the company is profitable and has therefore created value for its owners.
Statement of financial position value is not a proxy for a company’s market value but it gives an indication of the level of dividends that a company could potentially pay in the future.
2. Valuation on Break-up basis
Business valuation that is based on breakup basis assumes that the value of a business is the sum total of the monetary value of its individual assets. This basis will only be used when a business in the process of liquidating or being wound up. This method can also be used when management decides to sell up the assets of a company to raise cash.
3. Valuation through Market value analysis
The market price is theoretically the fair value for the share price of a company. This is what buyers and sellers are willing to exchange value on behalf of the company in an arms-length basis.
There are number of factors that could influence the market value of a company’s’ share. These include but not limited to: Major announcement, Change in management, better than expected profit forecast, Potential bid takeover, R&D breakthrough, etc.
Valuation of a company from the perspective of market value is the most relevant one as far as shareholders are concerned as this is consistent with meeting their financial objective which is to maximise shareholders’ wealth.
After ascertaining the value of the shares of the company, we will then add any increment (purchase price less current market price) experienced by the investor to the dividend yields.
Shareholders wealth comes from two primary sources- dividend received and the market value of shares held at a particular point in time and through those sources, we can measure the wealth or value of shareholders.
I hope that this short post provides an answer to your question of ‘how do we measure shareholders’ wealth?
Feel free to ask any further question in the comment section below.