Methods for Valuation of Equity Shares

Every listed company has two prices attached to its shares: the one flashing on the stock exchange ticker, and the one an analyst believes it should actually be worth. These two numbers rarely match exactly, and figuring out the gap between them is what the valuation of equity shares is all about. Whether you are pricing an IPO, working on a merger, or simply deciding whether a stock is worth buying, you need a systematic way to convert a company’s earnings, dividends, and growth outlook into a single rupee figure per share. This post walks through the three most widely taught approaches to this problem: the dividend discount model, the earnings-based approach, and market multiples, along with the assumptions that quietly decide the final answer.

Why valuing a share is not a simple calculation 🔗

Unlike a bond, which promises fixed interest and a maturity value, an equity share carries no guaranteed cash flow. A shareholder’s return depends entirely on what the company does with its profits: distribute them as dividends, plough them back into growth, or some mix of both. This is precisely why valuing shares is often described as an imprecise exercise that leans heavily on judgment rather than a single mechanical formula, since asset-based, income-based, and market-based approaches can each produce a different number for the very same company, and the appropriate method often depends on the purpose of the valuation and the regulatory framework it falls under, whether that is the Companies Act, SEBI norms, or accounting standards like Ind AS.

The dividend discount model 🔗

The dividend discount model, or DDM, is the oldest and most conceptually clean of the three approaches. It treats a share exactly the way you would treat any income-generating asset: its worth today equals the present value of every future cash flow it hands you, discounted at a rate that reflects how risky that cash flow is. For an equity shareholder, that cash flow is the dividend, because as owners of the business, shareholders hold a claim on the future cash the company generates, and this insight forms the foundation of every discounted cash flow model used in equity valuation today, an idea that traces back to economist John Burr Williams’ work from 1938.

The Gordon growth model 🔗

The simplest version of the DDM assumes a company pays a dividend that grows at one constant rate forever. This is called the Gordon growth model, and it is written as:

Value per share = D1 ÷ (k − g)

Here, D1 is the dividend expected next year, k is the required rate of return that shareholders demand for taking on the stock’s risk, and g is the constant rate at which the dividend is expected to grow indefinitely. Say a company is expected to pay a dividend of ₹8 per share next year, investors require a 12 percent return, and the dividend is expected to grow at 6 percent a year forever. The value per share works out to 8 ÷ (0.12 − 0.06), or roughly ₹133. Raise the growth assumption by even one percentage point and the value jumps noticeably, which is exactly why this model is best suited to large, mature, dividend-paying companies rather than young or cyclical businesses.

The multi-stage dividend discount model 🔗

Few companies grow at one steady rate for their entire life. A business typically moves through a high-growth phase, a slower transition phase, and finally a mature phase where growth stabilises. Analysts capture this by using a two-stage or multi-stage dividend discount model, applying a higher growth rate for the initial years and a lower, sustainable growth rate thereafter. This is more realistic than the single-stage version but also demands more forecasting, since you now need separate assumptions for each phase.

The earnings-based approach 🔗

Dividends are only useful for valuation when a company actually pays them regularly. Many growing Indian companies reinvest most of their profits instead of distributing them, which makes the DDM difficult to apply. The earnings-based approach solves this by working directly with a company’s profitability rather than its dividend policy.

Price-to-earnings (P/E) multiple method 🔗

The most commonly used earnings-based technique values a share as a multiple of its earnings per share (EPS):

Value per share = EPS × P/E ratio

The P/E ratio itself can be drawn from the company’s own historical average, from comparable listed companies, or from the broader industry. If a company earns ₹15 per share and comparable firms in its sector trade at a P/E of 18, the share would be valued at roughly ₹270. Academic research on the Indian market has specifically tested this against other earnings multiples and found that the historical price-to-earnings ratio outperforms other combinations of value drivers when forecasting prices in the Indian environment, which is one reason the P/E ratio remains the most widely quoted valuation metric in Indian financial media and brokerage reports.

Earnings capitalisation method 🔗

A close cousin of the P/E approach is the earnings capitalisation method, which divides a company’s expected maintainable profit by a capitalisation rate, essentially the inverse of a P/E multiple, to arrive at the value of equity. This method strips out one-off gains or losses and focuses on the profit a company can sustainably generate year after year, making it a favourite for valuing shares in closely held or unlisted companies where market multiples are harder to find.

Market multiples: valuing a share by comparison 🔗

The third broad approach sidesteps forecasting altogether and instead asks a simpler question: what are similar companies worth in the market right now? This is called relative valuation, and it is built on the idea that comparable businesses, facing similar risks and growth prospects, should trade at broadly similar multiples of their financial metrics. It is one of the two techniques Indian market professionals are formally trained on, alongside the Gordon growth model, as part of relative valuation methods that use P/E, price-to-book value, EV/EBITDA, and market capitalisation-to-sales ratios.

Commonly used market multiples 🔗

Each of these ratios is used by investors to compare a company’s market value against its financial fundamentals and against its industry peers. The advantage of market multiples is speed and simplicity, but the method is only as good as the peer group you choose. Pick the wrong comparable companies, and the resulting valuation will be misleading regardless of how carefully the arithmetic is done.

Why growth rates, earnings projections, and market conditions matter 🔗

All three approaches above eventually run into the same problem: they depend on assumptions about the future, and small changes in those assumptions can swing the final value quite dramatically.

Growth rate assumptions 🔗

In the Gordon growth model, the difference between assuming 5 percent and 7 percent perpetual growth can change the value per share by a large margin, since growth sits in the denominator alongside the discount rate. Analysts typically anchor long-term growth assumptions to a country’s expected nominal GDP growth, on the reasoning that no company can outgrow the entire economy forever without eventually dominating it.

Earnings projections 🔗

The earnings-based and market multiple approaches are only as reliable as the earnings forecast feeding into them. A company expected to report a one-time jump in profit due to an asset sale, a tax refund, or a favourable currency movement will show an artificially low P/E ratio that does not reflect its ongoing earning power. This is why analysts usually work with normalised or maintainable earnings rather than the latest reported profit figure.

Market conditions 🔗

Finally, no valuation model operates in isolation from the broader market. Interest rates influence the discount rate used in the DDM, sector sentiment and liquidity influence the P/E multiples the market is willing to pay, and periods of high volatility can push actual share prices well away from what any model suggests they should be worth. This is exactly why professional valuers rarely rely on a single method. Comparing outputs across the dividend discount model, the earnings approach, and market multiples gives a more grounded sense of where a share’s fair value likely sits, even when each method alone tells a slightly different story.

Bringing the three approaches together 🔗

In practice, these methods are complementary rather than competing. The dividend discount model works best for stable, dividend-paying companies with a long operating history. The earnings approach is useful when a company retains most of its profits or when you need a quick, comparable figure. Market multiples are fast and intuitive but depend heavily on finding the right peer group and a market that is not itself mispriced. A careful analyst usually triangulates between all three, treating any large divergence between them as a signal to dig deeper into the assumptions rather than as proof that one method is simply wrong.

What do you think? If a fast-growing company you’re tracking pays no dividend at all, which of these three approaches would you lean on first, and why? And when two valuation methods for the same stock give wildly different answers, what does that gap actually tell you about the assumptions built into each one?

References

1. https://cleartax.in/s/valuation-of-shares
2. https://www.cfainstitute.org/insights/professional-learning/refresher-readings/2026/discounted-dividend-valuation
3. https://www.researchgate.net/profile/Asheesh-Pandey/publication/267794616_Equity_valuation_using_price_multiples_Evidence_from_India/links/55504f4a08ae956a5d24b4ea/Equity-valuation-using-price-multiples-Evidence-from-India.pdf
4. https://www.nseindia.com/static/learn/financial-modelling-and-equity-valuation
5. https://www.kotakneo.com/stockshaala/valuations/valuation-multiples-explained/