How are book value and market value different?
While investors have many parameters to determine the valuation of a company’s stock, two of the most commonly used are book value and market value. Both ratings can be useful in calculating whether a stock is fair, overvalued, or undervalued. In this article, we’ll dig deeper into the differences between the two and their use by investors and analysts.
Key points to remember
- The book value of a business is the amount of money shareholders would receive if the assets were liquidated and the liabilities paid off.
- Market value is the value of a company according to the markets, based on the current price of shares and the number of shares outstanding.
- When the market value is less than the book value, the market does not believe that the business is worth the value of its books.
- A market value greater than the book value means that the market places a high value on the company due to the expected increases in profits.
The book value of a share is theoretically the amount of money that would be paid out to shareholders if the company were liquidated and paid off all of its debts. As a result, the book value is equal to the difference between the total assets and the total liabilities of a business. The book value is also recorded in equity. In other words, book value is literally the value of the business according to its books (balance sheet) after all liabilities are subtracted from assets.
The need for book value also arises when it comes to generally accepted accounting principles (GAAP). According to these rules, durable goods (such as buildings and equipment) on a company’s balance sheet can only be declared on the basis of their book value. This sometimes creates problems for companies whose assets have appreciated greatly – those assets cannot be revalued and added to the overall value of the company.
The difference between book value and market value
Calculating the Book Value of Bank of America Corporation (BAC)
You will find below the balance sheet for the year ending in 2017 according to the bank’s annual 10K statement.
- Assets totaled $ 2,281,234 billion.
- Liabilities totaled $ 2,014,088 billion.
- The book value was $ 267,146 billion at the end of 2017.
In theory, if Bank of America liquidated all of its assets and paid off its debts, it would have about $ 267 billion left to pay its shareholders.
Market value is the value of a business according to the financial markets. The market value of a company is calculated by multiplying the current share price by the number of outstanding shares that are trading in the market. Market value is also called market capitalization.
For example, at the end of 2017, Bank of America had over 10 billion shares outstanding (10,207,302,000) while the stock was trading at $ 29.52, bringing the market value or Bank of America market capitalization at $ 301 billion (10,207,302,000 * 29.52).
Book value is literally the value of the business according to its books (balance sheet) after all liabilities are subtracted from assets.
How book value and market value are interpreted
When the market value of a business is less than its book value, it may mean that investors have lost confidence in the company. In other words, the market may not believe that the business is worth the value of its books or that there is enough future profit. Value-oriented investors may seek out a company with a market value below its book value, hoping the market is wrong in its valuation.
For example, during the Great Recession, Bank of America’s market value was less than its book value. Now that the bank and the economy have recovered, the company’s market value is no longer trading at a discount to its book value.
When the market value is greater than the book value, the stock market places a higher value on the company because of the profit power of the company’s assets. Consistently profitable companies tend to have market values above their book values because investors have confidence in the companies’ abilities to generate revenue growth and profit growth.
When the book value is equal to the market value, the market sees no compelling reason to believe that the company’s assets are better or worse than what is shown on the balance sheet.
The bottom line
Book value and market value are two fundamentally different calculations that tell a story about the overall financial strength of a business. Comparing the book value to the market value of a company can also help investors determine whether a stock is overvalued or undervalued given its assets, liabilities and ability to generate income. However, with any financial measurement, it is important to recognize the limits of book value and market value and to use a combination of financial measures when analyzing a business.