Shareholder value is the return of an investment in a given company. Shareholder value is created when a company's returns exceed its cost of doing business. When a company's management team employs smart business decisions and is able to increase its earnings, share price, and dividends, shareholder value increases.
Making money on an investment is every investor's goal, so it's important to know how to calculate your shareholder value. Fortunately, it can be done in four easy steps.
To calculate an individual's shareholder value, we start by subtracting a company's preferred dividends from its net income. Preferred dividends are dividends paid to holders of preferred stock. Net income is a company's total earnings minus operating and non-operating expenses, depreciation, interest, and taxes.
If a company has a net income of $1 billion and pays out $200 million in preferred dividends, then it has $800 million in income available to shareholders.
Calculate the company's earnings by share by dividing the company's available income by its total number of shares outstanding. If a company has 400 million shares outstanding, then we can divide $800 million by 400 million to get an earnings per share of $2.
Add the stock price to the earnings per share. If our company's stock is selling at $40 per share, then add $40 and the earnings of $2 per share to arrive at $42.
Now multiply the above total by the number of shares held by an individual shareholder. If a shareholder owns 10 shares, then their individual shareholder value is $420.
Shareholder value and free cash flow
Free cash flow is a measure of how much cash a company generates after accounting for capital expenditures. Free cash flow plays an important role in increasing shareholder value. If a company has more cash at its disposal, then it can pursue new opportunities that lead to greater profitability. it can also use that spare cash to boost its dividend.
Prioritizing shareholder value
Some companies focus on improving shareholder value to the detriment of their long-term health. For example, a company might implement massive layoffs in order to increase shareholder value in the short term. However, the company might later find itself unable to keep up on the innovation or production front because of those job cuts. This is why managers must strike a balance between catering to shareholders and preserving the long-term financial health of the companies they're tasked with running.
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