1/3: What determines the value of a share?

Before explaining what a dividend actually is, it is essential to fully understand what a share represents.

A title of ownership

Much like the title deed to someone's primary residence drawn up by a notary, a share is a security that certifies your status as an owner. When you are a shareholder in a company, you are an owner, or rather a joint-owner, of that company.

A share is therefore fundamentally different from a bond, which is a debt instrument (indicating that the company owes a certain sum to the person who lent the money or purchased the debt).

Thus, when shares are traded on a financial market, a portion of the company's ownership is transferred, in the same way that ownership of real estate could be transferred by selling or buying shares in a real estate investment company.

By virtue of this status, the shareholder naturally has rights and obligations towards the company. However, buying a share also has a significant economic implication. Through their share, the shareholder becomes an indirect owner of what the company possesses, at least in terms of economic value. It is important to keep this principle in mind to understand what a dividend is.

The concept of Enterprise Value

Logically enough, the value of a share is a reflection of what the company is worth (or more precisely, a reflection of the fractional interest that the share represents).

There are various ways to value a company (based on its earnings, its outlook, its assets...), although the ultimate goal is always to reach a result that can be broken down into two parts.

The first component is the Enterprise Value (often abbreviated as EV). This concept can be compared to the value of the goodwill or the value of the company's commercial activity, independent of its financial situation.

Imagine that through its activity, a company expects to generate $20,000 in operating profit and that industry standards value companies at 9 times their operating profit. The company in question would therefore have an Enterprise Value of $180,000.

The impact of the net position

Once the Enterprise Value is determined—that is, the valuation of the commercial activity—the next step is to look at the company's cash position. The company may indeed have a positive cash balance in its accounts, zero cash, or a negative cash position (debt).

The purpose of this adjustment is easy to understand. Let us return to our example of an Enterprise Value of $180,000, this time applied to two companies, A and B.

Company A has zero cash, which means that by buying Company A, a shareholder will gain access to $20,000 of profit per year.

With Company B, they will get the same thing. However, if Company B also has $50,000 of cash in its account, a buyer can, in addition to the earnings, take possession of $50,000 in cash. It therefore seems logical to pay more for Company B. If we consider that the value of the "goodwill" is $180,000, it would be logical to be willing to pay up to $230,000 for Company B.

Conversely, all else being equal, a buyer will pay less for a company with debt, since the earnings collected over time will be reduced by the debt that must be repaid.

Equity value and share price

Thus, the value of the capital (equity) is equal to the Enterprise Value (EV) plus cash or minus debt.

Determining the price of a share is then child's play. One simply divides this equity value (market capitalization) by the number of shares.

At this stage, it is easy to understand that any variation in a company's cash position changes its equity value and therefore the value of its shares.

This is exactly what happens when a dividend is paid, as the second part of our series will demonstrate.