What Is Book Value?
The book value of a company is the difference between that company's total assets and its total liabilities, as shown on the company's balance sheet.
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Book Value Definition
Book value represents the carrying value of assets on a company's balance sheet and, in the aggregate, is equal to the shareholders equity after the book value of liabilities are deducted from assets. Investors often look at book value per share as a beginning estimate for what a company's shares may be worth if the company was completely liquidated. A key shortcoming of book value is that it ignores that the market value of many assets changes over time.
Note: Preferred shares are excluded from the book value per share calculation because these shares rank higher than common shares during the liquidation process.
As companies acquire new assets, those assets are recorded on the balance sheet at their cost. If a manufacturer buys assembly equipment for $20 million, it records that equipment at a book vaue of $20 million. Companies accumulate ownership of various types of assets over time, all recorded in their financial statements.
Assets on a company's balance sheet can include:
- Cash
- Cash equivalents, including Treasury bills and short-term certificates of deposit
- Investments
- Accounts receivable
- Inventory
- Property
- Plant
- Equipment
- Deferred Assets (such as prepaid expenses or prepaid taxes)
- Goodwill and other intangible assets
Liabilities on a company's balance sheet can include:
- Accounts payable
- Short-term borrowings
- Long-term debt
- Operating Leases
- Pension fund liabilities
- Deferred Liabilities (such as taxes due)
Book Value Formula
When defined as the difference between a company's total assets and its total liabilities, the formula for calculating book value is:
Book value = Total Assets - Total Liabilities
The formula is the same for calculating shareholders' equity or stockholders' equity.
A company that has assets of $700 million and liabilities of $500 million, would have a book value, or shareholders' equity, of $200 million.
Book Value Per Share Formula
The formula for determining book value per share, or BVPS, is:
BVPS = Book Value / Number of Shares Outstanding
A company that has a book value of $200 million, and 25 million outstanding shares would have a Book Value Per Share of $8.00.
Market Value Versus Book Value
It's critical to understand that market value of equity (or market capitalization) and book value of equity are different calculations and, in many situations aren't remotely close in value.
Market Capitalization reflects the economic value that investors assign to ownership of a public company's shares. Stock market investors will often assign incremental value to considerations like:
- a company's earnings power,
- excitement about a new product launch,
- management skill,
- an expected litigation victory etc.
For instance, consider a given company that has a market value approximately equal to its book value. Let's assume the company has mediocre profitability. The company then hires a famous turnaround manager which excites investors, who bid the shares higher. The market cap of this company increases, although the book value of the company hasn't changed.
Important: The market value of a publicly-traded company usually changes every business day, when stock markets are open. The book value of a company is updated much less regularly, typically quarterly when a public company registers their quarterly financial reports.
Price-to-Book (P/B) Ratio
The price-to-book (P/B) metric allows investors to compare a company's market capitalization to its book value, in the form of a ratio. If a company's market cap is twice as high as its book value, it will have a P/B ratio of 2.0x. If a company's market cap is three times as high as its book value, it will have a P/B ratio of 3.0x.
The Price/Book ratio is commonly used by value investors to help them screen for potentially undervalued (or overvalued) stocks. The P/B ratio can be calculated either at a total value level, or at a per share level.
P/B = Market Capitalization / Company Book Value
P/B = Share Price / Book Value per share
A company that has a share price of $81.00 and a book value of $38.00 would have a P/B ratio of 2.13x.
What's a Good P/B Ratio?
Many value investors build their portfolio based on low P/B stocks. Conventionally, a company with a P/B ratio below 1.0x is considered an attractive value investment, from the perspective that the book value of its assets is higher than the value the market is currently assigning. For example, consider a company with a $100 million book value, mostly in stable real-estate, trading at a P/B of 0.95. This implies a market value of only $95 million. Value investors see a $5 million undervaluation relative to book value that they believe will be corrected for over time.
It is critical for investors to understand the concept that there's no free lunch. It entirely possible that a company trading below book value will never recover that gap, or that book value itself might drop. If investors see a company trading below book value (or simply at a lower book value than peer companies), they might benefit from asking why it is so - why is the market valuing this company so low? Often, there's a reason.
Notably, in the case of bankruptcy and company liquidation, often assets are liquidated at a discount to book value. If a company holding $100 million of real estate launches a fire sale at liquidation prices, they may only raise $75 million, or less, from such sales.
In sum, there's no foolproof guarantee of investment returns, or investment safety, at a certain P/B level. A low P/B ratio usually suggests that a company, or its industry, or both, are out of favour. Some investors like to bet on value here, while others do not.
Limitations of Book Value
Companies typically report their book value quarterly, and this means that the latest book value may not reflect the company's updated performance on a given day during the new quarter. A company's accounting practices, especially regarding depreciation and amortization, can also significantly affect its book value. Two companies with highly similar assets, but different depreciation and intangible asset value assumptions may have wildly different P/B ratios.
Book value also can never be guaranteed to mean fair value, or minimum value. For companies in industries that are being disrupted (for example, a newpaper publisher), the carrying value of assets on the balance sheet may significantly overestimate the real economic worth of those assets.
It's also possible that a given company has liens applied against its assets, or is facing lawsuits that, if lost, could inflict losses that erode a large amount of its balance sheet value.
Bottom Line
The Book Value of a company is equal to their shareholders (or stockholders') equity, and reflects the difference between the balance sheet assets and the balance sheet liabilities.
One of the most frequent ratios tracked by value investors is the Price / Book ratio, which measures a company's market value versus its book value.
Investors tend to assign value to companies' growth and earnings potential, not just their balance sheet assets. As a result, most companies included in indices such as the S&P 500, the Dow Jones Industrial Average, and the Nasdaq Composite, possess market values that exceed their book values.
While many investors rely on book value as an indication of the approximate minimum value for a company, there are never any guarantees that economic value of the assets will not turn out lower than the most recently stated book value.
FAQs
No, the equity value, or market value, of a company is calculated by multiplying its share price by the number of shares outstanding, whereas the book value is the difference between a company's assets and its liabilities.
If a company's BVPS is greater than its market value per share, which is the same as its current stock price per share, then the company's stock is considered undervalued. If the price per share is greater than the BVPS, then the stock can be considered overvalued.
A company's book value can lull investors into a false sense of security, that if the company declared bankruptcy, they could still recoup their investment. However, assets sold following a bankruptcy are often sold at a steep discount, sometimes just pennies on the dollar.
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