Calculating Share Price

Share price is the price of one share of stock. Although it can appear like an arcane value, fluctuating with the market, share price is simply market capitalisation (company value) divided by number of shares issued by the company. A company with an IPO will usually have advisors to determine share price value for the company. Share price is determined before it is subjected to buyer and seller impact.

The company decides how many shares it wants to issue. If company A issues more shares, share price would be lower compared to company B that is of the same market capitalisation. Price to earnings (P/E) ratio is the measure of the share price divided by earnings per share.

For example, let's take a short term value stock (over one year). Assume price of stock ABC is currently $200 per share (P0). Dividends are expected to be $2 per share (Div). Price of Stock ABC is expected to be $205 per share after one year (P1). Capital gain is expected to be $205 - $200 or $5 per share.

First, let's calculate expected return. The formula is Expected Return = (Dividends Paid + Capital Gain) / Price of Stock. Therefore: Expected Return or R = ($2 + $5)/$200 = 3.5%

Expected return can now be used to calculate the price of stock in the same risk class as stock ABC using this formula: Stock Price = (Dividends Paid (Div) + Expected Price (P1)) / (1 + Expected Return (R)).

From our example above: Stock Price = ($2 + $205) / (1 + 0.035) = $207 / 1.035 = $200

Share price may or may not be fair price, as traders have different attitudes about what is 'proper.' Traders may decide to bid if share price is higher than last trade or they may sell a few shares, hoping to drive the price lower. Personalising your trading strategy is key to success.