As a continuation from lesson 6, let us assume that Samuel is unable to get one investor to buy the entire business or only wants to sell a small portion of it to investors. If he thinks the business is worth 100,000 shillings, he can split the business 10,000 times into small units called shares. Each share would be now worth $10.
The 10,000 shares are referred to as shares outstanding. It simply refers to how many times the business has been split into. It is very important to remember this since you will often see it being mentioned and it is the figure that you use in getting the value of the business you are buying per share.
Difference between whole business and the one share that you buy:
When buying that one share, worth 10 shillings, think about it like you are buying a very small business identical to the bigger business. The only difference is that you are only using less capital.
The book value is the amount of equity in the balance sheet divided by the number of shares outstanding.
Using Samuel’s business illustration if he split his business 10,000 times so that he can sell to many investors, we would have something like this; (remember he had an equity of 7,000 and was getting net profits of 20,000 shillings every year)
Amount of shares in the business: 10,000 shares
The market value (Value Samuel assigned to it): sh10 for every share (100,000/10,000)
Earnings distributed to each share: 20,000/10,000 = sh2
Book value: 7,000/10,000 = sh 0.7
As an emphasis, always value that one single share you buy like you would value the entire business.
In the next lesson, we are going to look at valuing a business in relation to the market price now in terms of per one share.