Calculation of the stock price of a family-owned company based on the comparative value of similar company

Principle valuation method for shares held by a family with a controlling interest

One of the most problematic issues in estate planning is the valuation of shares in the event of the founder’s death. FNational Tax Agencyt, it is necessary to check whether certain exceptions to the principle valuation method are applicable, and if not, the principle valuation method is likely to be used. The principle valuation method, the comparable industry method, is used for family shareholders who have a certain degree of influence over the company’s decision-making (family members with control). If a family shareholder has a certain influence on the company’s decision-making by holding a large number of shares or being appointed as a director, the net asset value method, the comparable industry method, or a combination of these methods will be used as the principle valuation method. On the other hand, the dividend capitalization method, which is a special valuation method, is used for shares held by family members who hold only a small number of shares and have very little influence on the company’s decision-making process. Minority shareholders whose shares have been passed down through generations and who do not directly touch the management of the company are not considered to be family members with control, and therefore, the special valuation method is used.

Comparable Industry Ratio Method as a Principle Valuation Method

Calculation Formula of the Comparable Industry Ratio Method

Therefore, we will now look at the formula based on the comparable industry method, which is the principle valuation method for shares held by a family with a controlling interest. The per-share price based on the comparable industry method is calculated by the following formula.

A×（B’/B＋C’/C＋D’/D）÷3×X

• A: Share price of similar industries
• B: Dividend per share of similar industry
• B’: Dividend per share of the company being evaluated
• C: Annual profit per share of similar industry
• C’: Annual profit per share of the company being evaluated
• D’: Book value per share of comparable companies
• D’: Book net asset value per share of the evaluated company

Average of listed company’s share price by industry

A （share price of similar industries） represents the average stock price of listed companies in the same industry as the company in question that are traded on a stock exchange. The National Tax Agency determines which listed companies are subject to valuation for each industry, and the average price can be found on the NATIONAL TAX AGENCY website. Stock prices for similar industries are updated monthly. For industry categories, there are major, medium, and minor classifications. Within the manufacturing industry, classifications differ depending on the type of products handled. Similarly, for the service industry, it is necessary to determine which stock price will be used as the reference price by referring not only to the major classifications but also to the medium and small classifications. As for the stock price of similar industries (average of listed companies), which is used as the basis for calculating the stock price, in the current valuation, either the previous month (one month prior), the previous two months (two months prior), the previous three months (three months prior), or the average of the previous year is to be used, but “the average of the previous two years” was added by the tax reform in 2017. This revision will reduce the impact of sudden fluctuations in the stock price of listed companies on the stock price of small and medium-sized companies.

Comparison of dividends with the average value of listed companies

B’ for B’ indicates the amount of dividend per share, which is how many times the company pays out compared to the average of listed companies. However, since the number of shares outstanding varies from company to company, a simple comparison of dividend amounts without comparing how many shares are issued will not be an appropriate comparison. The amount of dividends in similar industries is calculated based on the assumption that the number of shares issued is equal to the amount of capital divided by 50 yen, and how much dividend is paid per share. Therefore, for the subject company, instead of simply dividing the total amount of dividends by the total number of shares issued and outstanding, we have to calculate how much dividend is paid per share assuming that each share is 50 yen.

For example, suppose a company with capital of 10 million yen and 10,000 shares outstanding pays an average annual dividend of 1 million yen per share. Since the actual dividend is 1 million yen per 10,000 shares, the dividend per share would be 100 yen. On the other hand, if the total number of shares issued by the company is 100,000 shares, the dividend is 1,000,000 yen per 100,000 shares, so the dividend per share is 10 yen. As shown above, the number of shares issued by a company varies from company to company, so unless a standard number is determined, comparisons cannot be made.

Therefore, the above formula calculates the amount of dividend per share assuming 50 yen per share, regardless of the actual number of shares issued. In the above example, the company is capitalized at 10 million yen, so if the issue price is 50 yen per share, 200,000 shares have been issued. Therefore, we would divide the average annual dividend amount of 1 million yen by 200,000 shares and calculate that the company is paying a dividend of 5 yen per share.

What may seem a little strange here is that the capital is divided by 50 yen for comparison. A company’s capital is not simply the total issue price of its shares, but the amount of the issue price that is incorporated into equity, and some companies may incorporate the entire issue price into equity, while others may incorporate only half of the issue price into equity. Therefore, the total issue price does not necessarily equal the amount of capital. In addition, since the amount of capital can be reduced by a resolution of the shareholders’ meeting after the company has issued shares, one might wonder whether the same calculation method can be used when a capital reduction is carried out. However, since it would be almost impossible to make comparisons if all such issues were considered, it is assumed that comparisons are simply made based on the current amount of capital in the calculation of the comparable industry value. Capital and legal reserves will not be considered at this stage.

Based on the above, let us consider B’/B. For example, if a company pays a dividend of 1 yen per 50 yen per share in a similar industry (this would be based on the figures listed on the NATIONAL TAX AGENCY website), and the company is paying a dividend of 2 yen per 50 yen per share in an evaluated company, B’/B would be twice the comparable industry Similarly, if the company pays a dividend of ¥5 per share, B’/B will be twice that of the comparable industry. In reality, the comparable industry pays a dividend of ¥1.1 and the appraised company pays a dividend of ¥3.2, and so on. In this case, the multiple would be 3.2 yen/1.1 yen, or 2.909.

Profit comparison with the average of listed companies

Similarly, we will look at C’/C. Here again, we will compare the profit when 1 share is considered to be 50 yen. For example, if the capital of the company to be evaluated is 10 million yen, the total number of outstanding shares is 10,000 shares, and the annual profit is 30 million yen, simply dividing the annual profit by the total number of outstanding shares will result in 3,000 yen. As stated above, 10 million yen in capital divided by 50 yen equals 200,000 shares, so when calculating the amount of profit per share of 50 yen, 30 million yen should not be divided by 10,000 shares, but by 200,000 shares. Therefore, 30 million yen divided by 200,000 shares = 150 yen, which means that the annual profit per share of 50 yen is calculated to be 150 yen.

The C’/C is then calculated by dividing 150 yen by 30 yen, which is 5 times, in case the amount of profitof a similar industry is 30 yen on the National Tax Agency’s website.

In the past, in calculating the stock price of a closed company, the C’/C was further multiplied by 3, based on the idea that the amount of profit was important and needed to be given greater weight when making comparisons. In the above example, the figure would be 5x x 3 = 15x. However, due to the tax reform of 2009, this point is no longer treated as a factor of 3, so the figure is now 5 times the value of the weight (as in the example above) instead of 15 times.

Comparison of net asset value with the average of listed companies

The next step is to calculate D’/D in the same way, where D means the net asset value per share on the books of a similar industry. It is important to note that, in the case of inheritance tax valuation, real estate and other assets owned by the company must be recalculated based on the inheritance tax assessed value, not simply the book value. For example, if the land acquired by the company 30 years ago has a book value of 300 million yen based on the acquisition price, but the inheritance tax assessed value (roadside land value) is 500 million yen, the net assets must be recalculated based on the inheritance tax assessed value.

So, for example, if the net assets of an evaluated company (capitalized at 10 million yen) is 300 million yen, 300 million yen would be divided by 200,000 shares, and the net assets per share would be calculated as 1,500 yen. On the other hand, if, for example, the book net asset value per share for a comparable industry is ¥2,000, the value of D’/D would be ¥1,500 divided by ¥2,000 = 0.75.

Calculation of comparative value of similar company

Based on the above, we will look at A x (B’/B + C’/C + D’/D) / 3 x X.

As for A, as mentioned above, it can be found on the NATIONAL TAX AGENCY website, and here, for example, we assume that the stock price of the relevant similar industry is 300 yen. Applying these figures, we arrive at the following:

300 yen x (2/1 + 150/100 + 1500/2000) / 3 x X

• A: Share price of similar industry 300 yen
• B: Dividend per share of similar industry 1 yen
• B’: Dividend per share of the company being evaluated ¥2
• C: Annual profit per share of similar industry 100 yen
• C’: Annual profit per share of the evaluated company 150 yen
• D: Book value of net assets per share in a similar industry ¥2,000
• D’: Book net asset value per share of the evaluated company 1,500 yen

Again, let us look at the formula for calculating the per share value using the comparable industry method.

A×（B’/B＋C’/C＋D’/D）÷3×X

• A: Share price of similar industries
• B: Dividend per share of similar industry
• B’: Dividend per share of the company being evaluated
• C: Annual profit per share of similar industry
• C’: Annual profit per share of the company being evaluated
• D’: Book value per share of comparable companies
• D’: Book net asset value per share of the evaluated company

The values of A, B, C, and D have already been determined and calculated as follows:

300 yen x (2/1 + 150/100 + 1500/2000) / 3 x X

• A: Share price of similar industry 300 yen
• B: Dividend per share of similar industry 1 yen
• B’: Dividend per share of the company being evaluated ¥2
• C: Annual profit per share of similar industry 100 yen
• C’: Annual profit per share of the evaluated company 150 yen
• D: Book value of net assets per share in a similar industry ¥2,000
• D’: Book net asset value per share of the evaluated company 1,500 yen

Conscientiousness Ratio

Finally, we will consider the conscientiousness ratio, X. The conscientiousness ratio varies depending on the size of the company. The percentage of consideration depends on the size of the company: 0.7 for a large company, 0.6 for a medium company, and 0.5 for a small company. The last calculation is the ratio of the company’s value to the average value of the listed company’s assets.

For example, if the average share price of a listed company in a similar industry is 100 yen, and the amount of dividends, annual profit, and net asset value on the books are exactly the same as the average of similar industries, the value of A x (B’/B + C’/C + D’/D) / 3 is 100 yen. However, the value calculated by the comparable industry method is 70 yen for a large company, 60 yen for a medium company, and 50 yen for a small company, because the conscientiousness factor is applied. The reason why the value calculated by the comparable industry method is smaller than that of a listed company is because of the lack of liquidity in the case of an unlisted company.

Classification by Company Size

The question then becomes how to distinguish between large, medium, and small companies. The NATIONAL TAX AGENCY has established standards on this point as well, and different standards are used for wholesale, retail, and service businesses and for other types of businesses (e.g., manufacturing). For example, for companies that are not in the wholesale, retail, or service industry, the classification by size is as follows:

Large size of the company
Net assets of at least 1 billion and more than 50 employees, or transactions of at least 2 billion

Medium to large size of the company
Net assets of 700 million or more and more than 50 employees, or transactions of 1.4 billion or more but less than 2 billion

Medium to medium size of the company
Net assets of 400 million or more and more than 30 employees, or transaction value of 700 million or more and less than 1.4 billion

Small to medium size of the company
Net assets of 50 million or more and more than 5 employees, or transaction amount of 80 million or more but less than 700 million

Small size of the company
Net assets less than 50 million or employees less than 5 or transactions less than 80 million

Weighting

Of the above, net assets and number of employees are “and”, so both conditions must be met. For example, a company with net assets of ¥800 million and 80 employees would not meet the “more than ¥1 billion and more than 50 employees” requirement and would not meet the requirements for a large company with respect to this requirement. Similarly, a company with net assets of 500 million yen and 20 employees has net assets of 400 million yen or more but less than 30 employees.
In addition, the “net asset/employee criterion” and the “transaction amount criterion” are linked by “or”, so it is sufficient to satisfy one of the conditions above. For example, a company with net assets of 800 million yen and 40 employees does not meet the “net assets of 1 billion yen or more and more than 50 employees” requirement, but if the transaction amount is 2.1 billion yen, the company meets the “transaction amount of 2 billion yen or more” requirement and thus falls under the “large company” category.

Thus, the company is fNational Tax Agencyt checked whether it is a large, medium, or small company, and then multiplied by one of the following values: 0.7, 0.6, or 0.5, depending on the size of the company. In the case of inheritance tax assessment, or in the case of family share sales and purchases, the company may want to calculate a lower share price, and therefore may consider a medium-sized company more advantageous than a large company, or a small company more advantageous than a medium-sized company. Conversely, in the case of M&A, etc., if a company wishes to increase the valuation of its shares and sell them for a higher price, it may wish to be classified as a large company in order to increase its share price.

However, the classification of a large, medium, or small company is objectively determined based on the company’s financial statements, so in general, the parties concerned cannot manipulate the classification on their own. However, it may be possible to adjust the number of employees to some extent, or to increase or decrease the amount of transactions (sales) to a higher or lower classification by extending sales or, conversely, saving sales, if the figures are extremely high. There is room to do so.

In addition to the above-mentioned conscientiousness ratio, it is also necessary to consider the weighting between the comparable industry value and the net asset value when calculating the stock price based on the comparable industry method, as described below. For example, in the case of inheritance, it is not necessarily more advantageous to classify a company in the lower category, even if the company wishes to lower its assessed value for inheritance tax purposes. The lower the classification, the greater the weight of net asset value, so even if the comparable industry value is lowered, the higher net asset value may result in a higher share price. In this regard, whether the comparable industry value or the net asset value will result in a lower share price is determined on a company-by-company basis, depending on the financial condition of each company, so it is impossible to make a general judgment as to whether the upper or lower classification is more advantageous without making a final calculation.

Based on the above calculations, if the company to be evaluated is a medium-sized company, the consideration ratio is 0.6, and the formula (calculation of share price) based on the comparable industry method is as follows:

300 yen x (2/1 + 150/100 + 1500/2000) / 3 x X
＝300 x (2+1.5+0.75)/3 x 0.6
= 255 yen

In the case of this company, the dividend is 2 yen per 50 yen, which is twice the average of listed companies in similar industries, and the profit is 1.5 times the average of listed companies in similar industries, but the net assets are smaller than those of similar companies (3/4). In addition, the value of the company is somewhat lower than the average value of listed companies in similar industries.

However, when calculating the stock price based on the comparable company method, it is necessary to consider the weighting of the net asset value.

The weighting depends on the size of the company. The criteria for determining the size of a company are the same as above. The weighting ratios are as follows:

Large size of the company
Comparable industry value 100%.

Medium to large size of the company
Comparable industry value x 0.9 + Net asset value x 0.1

Medium to medium size of the company
Comparable industry value x 0.75 + Net asset value x 0.25

Small to medium size of the company
Comparable industry value x 0.6 + Net asset value x 0.4

Small size of the company
Comparable industry value x 0.5 + Net asset value x 0.5

The net asset value is simply determined by dividing the net assets by the total number of shares outstanding. However, even in this regard, the net asset value per share of 50 yen per share must be calculated.

For example, if a company has capital of 10 million yen, 10,000 shares outstanding, and net assets of 300 million yen, simply dividing 300 million yen by 10,000 shares will give net assets per share of 30,000 yen. This is how P/B ratio is calculated for listed companies, etc. On the other hand, the calculation of the share price using the comparable company method is based on the assumption of 50 yen per share, so 10 million yen is divided by 50 yen, and the calculation is made on the assumption that 200,000 shares are issued. In this example, the net asset value is calculated as follows:

300 million yen / 200,000 shares = 1,500 yen

As in this example, for many companies, the net asset value would be higher than the comparable company value. In this case, the smaller the company is, the greater the weight of the net asset value will be, resulting in a higher share price. In the case of an inheritance tax assessment, the share price would be calculated as low as possible, so in the above example, the larger the size of the company, the more favorable the share price would be. In this way, the larger company would have a higher share price in terms of the percentage of consideration, while the smaller company would have a higher share price in terms of the weighting between the comparable industry value and the net asset value. The decision of which is more advantageous should be based on the company’s situation, taking into consideration both the ratio and the weighting of the comparable companies.

If the size of the company to be evaluated is “medium of medium,” the valuation ratio based on the comparable industry method would be 0.75 and the valuation ratio based on the net asset value would be 0.25, as described above. Thus, the company’s share price per share of 50 yen would be as follows:

255 yen x 0.75 + 1500 yen x 0.25 = 191.25 yen + 375 yen = 566.25 yen

Although the value of the company to be evaluated was lower than the average value of similar companies listed on the stock exchange in terms of comparable industry value, the higher valuation in terms of net asset value resulted in a share price that was ultimately higher than the average value of similar companies (300 yen).
During the inheritance phase, one would want to reduce inheritance taxes as much as possible, so it is necessary to consider what modifications should be made to the company’s financial position, taking into account the above calculation method, in order to prepare for inheritance taxes. For example, in calculating the comparable industry value, three factors are taken into account: dividends, profits, and net assets of the company being evaluated, so simply reducing the dividends (e.g., to zero) will considerably lower the assessed value.

However, if the dividends are reduced to zero and the company had zero profits in the previous year when the inheritance occurred, the company will have neither dividends nor profits, and two or more of the three factors will be zero, making the comparable company method unusable (as explained in the fNational Tax Agencyt paragraph, the net asset value method, which is a special case rather than the principle method of valuation, will be used). It is necessary to consider the stock price with these points in mind.

Adjustment by number of shares

Finally, the calculation of the stock price of the comparable company requires an adjustment to the number of shares actually issued. The above calculation assumes a stock price of 50 yen per share, but in the above example, only 10,000 shares were actually issued, not 200,000. Therefore, the calculation according to the actual number of shares issued and outstanding would be as follows:

566.25 yen x 200,000 shares / 10,000 shares = 11,325 yen

This means that the company’s stock price is calculated to be 11,325 yen. Since the total number of outstanding shares is 10,000 shares, the total market value of the shares is 113,250,000 yen. If the decedent owned 80% of the total number of shares issued and outstanding, the value of the shares as inherited property would be as follows:

113.25 million yen x 0.8 = 90.6 million yen

The calculation of inheritance tax and the amount of inheritance in the division of the estate will be based on this amount.