Summary

This third pillar is in three parts. I will start with a short consideration of the theory underpinning what sets the share price. This section builds on what was introduced at an early stage in this book in the Financial Markets building block on pages 41–46. Here we learned how the conventional wisdom is that share prices are set by the present value of a company's future dividends. I will return to this idea, work with it a little more and test it by considering some of the problems that exist with the theories.

The two main parts of the pillar will be devoted to the practical topic of calculating share prices and to the more cerebral topic of the implications for understanding and targeting performance of the conclusion that value does underpin the share price. I will deal with how to calculate a share price first but since these two sections can be read on their own, readers can switch the order if they so wish.

My suggested practical approach to company valuation will start with a plan. I will explain that this should typically cover a period of three to five years but that a valuation can be carried out with just a single year's worth of data if that is all one has available. The next step requires the calculation of a terminal value. I will set out several ways of doing this and point out some potential errors to avoid. These two steps will give the so-called asset valuation of a company.