Last Updated on October 26, 2023 by BFSLTeam BFSLTeam
With volatile markets giving ample opportunities for potentially profiting from short-term price movements, long-term investment in the stock market is an art that few investors truly master. However, if you are interested in eliminating the risks of short-term market volatility and truly tapping into the growth potential or value offered by a company, it is essential to remain invested in the company over the long term. This is because it takes a few years for any company to establish itself, stabilise its profits and start delivering shareholder value. But what is the meaning of shareholder value anyway? And why is it important? Let’s find out.
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Definition and Meaning
Shareholder value refers to the increase in the value of shareholders’ investments over time. One of the primary objectives of a company, especially the ones listed on the stock exchanges, is to deliver shareholder value through strategic business decisions that increase earnings and ultimately profits. As a result, shareholders get to enjoy an increase in the dividend payout and appreciation in the price of the shares they hold.
Now that you know the meaning of shareholder value, let’s focus on getting to know the different financial and non-financial factors that drive shareholder value. As an investor, being aware of these value drivers can help you make a well-informed investment decision.
- Earnings Growth
An increase in revenue is one of the major factors that drive shareholder value. Consistently delivering earnings growth is likely to lead to an increase in the value through share price appreciation.
- Capital Expenditure
Capital expenditure refers to the funds that are invested in the acquisition or upgradation of long-term assets like equipment, plant and machinery, technology and infrastructure. Investing heavily in capital assets may lead to higher revenues and an increase in shareholder value.
- Working Capital Management
Working capital refers to the funds a company requires to meet its expenses arising from its day-to-day business operations. Companies that manage their working capital efficiently are generally viewed positively and have a greater chance of generating shareholder value.
- Competitive Advantage
A strong competitive advantage can enhance a company’s ability to deliver shareholder value. Competitive advantage can be the form of innovation, technology, product and service quality, supply chain efficiency and a strong distribution network.
- Dividend Payment
Distributing dividends regularly can create shareholder value over time. Dividends can be in the form of cash or additional shares issued for free (bonus shares).
- Efficient Use of Resources
Efficiently using resources can lead to higher returns on investment. This positively impacts shareholder value and may lead to wealth creation in the long term.
If you invested in the shares of a company or plan on doing so in the future, you need to know how to calculate the shareholder value. Fortunately, all you need to do to compute this value is use the following mathematical formula.
| Shareholder Value = (Earnings Per Share + Current Market Price) * Number of Shares Owned |
Here’s a hypothetical example to help you understand how the calculation works.
Assume you own 150 shares of ABC Limited. The Company’s Earnings Per Share (EPS) as of March 31, 2023, stood at ₹80 per share. The market price of the company’s stock as of March 31, 2023, was ₹680 per share. Substituting these values in the above-mentioned mathematical formula should give you your shareholder value.
Shareholder Value = ₹1.14 Lakhs [(₹80 + ₹680) * 150]
There are many ways through which a company can boost its shareholder value. Here’s a quick overview of some of the most popular methods that companies employ.
- Improve Financials
To create shareholder value, a company must first focus on improving its financial situation. Increasing sales, implementing a strong marketing strategy and expanding to new markets can lead to revenue growth. Meanwhile, improving operational efficiency and reducing costs can boost profit margins. All of this combined can help contribute to an increase in shareholder value.
- Innovate and Differentiate
Innovation and differentiation not only drive growth but can also create a competitive advantage. And as you’ve already seen, having an advantage over industry peers is one of the major drivers of shareholder value. However, innovation and differentiation involve significant capital expenditure, which may only be possible if the company improves its financial situation first.
- Effectively Allocate Capital
Allocating capital towards projects and businesses that have the potential to deliver strong returns in the future is one of the ways in which a company can create shareholder value. However, when allocating capital, it is advisable to exercise caution and assess the opportunities thoroughly before investing.
- Buy Back Shares
A share buyback improves Earnings Per Share (EPS) by reducing the number of outstanding shares in the market. The announcement of such a corporate action may also have a positive impact on the current market price, leading to an increase in shareholder value.
- Merge or Acquire
Another good way to enhance shareholder value is through a merger or an acquisition. Strategically planned mergers or acquisitions can expand a company’s operational capabilities, market share and customer base. Furthermore, the newly combined entity is also likely to benefit from higher EPS, which can enhance shareholder value.
Conclusion
Shareholder value has often been a topic of contention. This is because while it is always a positive indicator to add value to the company’s owners, it may not be an indicator of the value that a company adds to its other stakeholders — like employees and customers. It is also not an indicator of how sustainable and well-governed a company is.
So, if you are a long-term investor in any company, the shareholder value is not the only parameter to consider. You also need to look into the company’s management, its future growth prospects, its sustainable initiatives and the ethical practices it follows. This will help ensure that the company you’ve invested in is future-proof.
