What Is Book Value?
A company’s book value tells investors how much money would be left if a company ceased its operations, paid off existing debts, and sold all assets. It represents an organization’s basic net worth. One uses this metric to compute a company’s valuation based on its liabilities and assets.
For companies, it is a crucial figure to monitor growth. Moreover, investors view it as a real-time value indicator. In other words, one can use this metric to determine if a company’s shares are overvalued or undervalued. Hence, this metric is useful for value investors seeking stocks trading at a price less than their intrinsic value.
Table of contents
- Book value meaning refers to a measure of a company’s basic net worth.
- Value investors use this metric to check if a stock is undervalued or overvalued.
- One can calculate book value by subtracting a company’s total liabilities from the total tangible assets. To calculate BVPS, individuals must divide the shareholders’ equity by the total number of outstanding shares.
- This metric has certain limitations. For example, it does not consider a company’s intangible assets. As a result, a company’s shareholder’s equity would be lower than the company’s actual worth.
Book Value Explained
Book value meaning implies the amount a company’s shareholders will receive if the business shuts down without selling its assets at a loss and settles its debt. Using this metric, one can compute a company’s actual worth based on its assets and liabilities. Investors often use this figure to judge whether a stock is overvalued or undervalued.
The shareholders’ equity book value alone doesn’t provide one with adequate data regarding a company’s potential return and real value. For instance, let us say that Company A and Company B have net worths of $10 million and $12 million, respectively. This does not mean that the latter is the better investment option. Hence, investors consider other metrics along with this figure to compare stocks.
One way of comparing two companies is to calculate the book value per share (BVPS). One can calculate it by dividing shareholders’ equity by the total number of outstanding shares. For example, if a company has shareholders’ equity worth $5 million and 100,000 outstanding shares, its BVPS is $50.
Another way of comparing companies involves using the price-to-book (P/B) ratio. This financial ratio compares a company’s market price to its book value. Typically, a P/B ratio of over 1 indicates an overvalued company. On the other hand, if it is below 1 indicates an undervalued company.
For example, let us say that Company X stock trades at $15 per share while Company Y trades at $12 per share. The former and latter have a BVPS of $5 and $48, respectively. Therefore, the P/B ratios are as follows:
- Company X – 3
- Company Y – 0.25
Company Y appears to be a better investment option as its stock price can increase to align with its value in the future, generating significant returns for investors.
Book Value, Face Value & Market Value – Video Explanation
The book value per share formula is as follows:
BV = A – L
- BV = Book value
- A = Total tangible assets
- L = Total Liabilities
With the help of the above figures, one can get a clear idea of a company’s current tangible value.
Let us look at this book value example to understand the concept better.
Suppose Company ABC has total assets worth $500 million, including intangible assets (trademarks, patents, goodwill, etc.) worth $100 million. The total liabilities of this company stand at $200 million.
One can calculate book value using the above formula.
BV = A – L
Or BV = $400 million – $200 million = $200 million
Book Value vs Face Value
Also known as nominal or par value, face value is a company’s value listed in the books and share certificate. The company fixes this value once it decides to issue its shares. On the other hand, book value is the value of shares in a company’s book of accounts. In other words, it is the amount that shareholders can get when a company decides to wind up and sell its assets to repay its debt.
In simple terms, shareholders’ equity is a company’s net worth. One has to calculate it, unlike face value.
One of the most significant limitations of the book value per share formula is that it does not consider a company’s intangible assets like patents, trademarks, etc. Although such assets do not have tangible value on a company’s books, they offer significant value over time.
For example, a startup developing mobile-based applications might have a high market value because of its growth potential. However, a significant percentage of this high price could be based on future offerings, not current products.
In such cases, the shareholders’ equity would be less than the company’s actual worth.
A few other limitations are as follows:
- It considers historical costs when pricing specific assets, which may not be accurate. After all, there’s a chance that the values have increased significantly over time.
- This metric may not offer a clear picture if a company with substantial capital assets uses aggressive depreciation techniques.
Frequently Asked Questions (FAQs)
One can use the following formula to calculate the metric:
B = TC – AD
– B is the book value
– TC is the total cost
– AD is the accumulated depreciation
No, they are not the same. Book value is a company’s net worth calculated by deducting liabilities and intangible assets from total assets. In contrast, market value is a company’s overall value based on the current share price and the total number of outstanding shares.
This can happen when a company decides to retire or sell an asset. Fully depreciated assets and their salvage value reinforce an accountant’s position that depreciation is not a technique for valuing assets. Instead, it allocates an asset’s cost over its useful life.
Yes, it includes cash, as it is a tangible asset.
This article is a guide to What is Book Value & its meaning. Here, we explain its formula, limitations, calculation example, and difference from face value. You can also go through our recommended articles on corporate finance –