What is book value? Definition, how to find it, use to invest
- The book value of a business is the total value of all of its assets less all of its liabilities.
- Investors compare a company’s book value to its stock price, to determine whether the stock is undervalued or overvalued.
- Book value works better on durable goods companies than on service providers or companies with intangible assets.
When investigating which stocks to buy, investors often need to take a close look at company finances. One of the big things they look at is book value.
Book value is a calculation that aims to determine the true and complete value of a business, based on its assets. It’s basically breakout value – the amount the business would be worth if it were liquidated.
Investors use book value to help them judge whether a company’s stock is overvalued or undervalued.
Let’s dive deeper into book value, how it’s calculated, and what it means.
Book value actually has two related meanings. In the accounting world, book value refers to the value of a particular asset on a company’s balance sheet – say, a property or equipment. The book value of the asset is its original cost less depreciation (its decreasing value as it ages or wears out). It is mainly used for tax purposes.
In the investment/finance world, the meaning of book value is an expanded and extrapolated version of the first definition. It is the total value of all the company’s assets – the value of all goods, properties, funds and other things it owns – less its liabilities — its expenses and its debts. Usually, the value of any intangible assets, such as intellectual property or patents, is also subtracted.
This sum aims to quantify what a company is really “worth”. This is the amount that theoretically represents the liquidation value of the company. If the company went bankrupt or was broken up and sold, this book value would be used to determine what individual shareholders would receive – basically, the cash value of their individual shares.
How to calculate book value and book value per share
Book value is not often included in stock listings or a company’s online profile. To find its book value, you need to look at its financial statements, and all of the assets and liabilities listed on its balance sheets. Add up all the assets, subtract all the liabilities and the result is the book value.
Although you have to calculate book value yourself, most online stock listings include a related metric that’s also helpful to investors: book value per share (BVPS). Book value per share shows how many dollars each share will receive if a company is liquidated and its creditors repaid.
Expressed in dollars, BVPS breaks down the company’s overall book value by dividing it by all of the company’s outstanding shares, to get an amount per share. This amount can be compared to the current stock price.
Some sites also list this as a single number, called the price/book ratio.
For example, in late January 2021, Microsoft Corp. (MSFT) had a book value per share of $24.65 and a price-to-book ratio of 14, compared to a price of $242.
How Investors Use Book Value
Book value, book value per share, and price-to-book ratio are popular measures for value investing. This investment strategy boils down to bargain-hunting: rather than targeting the best-performing stocks, it seeks out low-priced and overlooked stocks in the hope that their price will rise again.
To find their bargains, value investors look at a company’s book value and book value per share. If a stock is trading below its book value, it could be a good buy – an undiscovered gem.
If the book value per share is higher than its market value per share – the current stock price – this may indicate an undervalued stock. If the book value per share is lower than its market value per share, this may indicate an overvalued or overvalued stock.
The reasoning behind this is that book value per share represents the financial strength of a company based on its assets, an objective number, while market value per share represents the attractiveness of a company’s shares in the market, a subjective number.
The limits of book value
Book value is best used with companies that have physical assets, such as plants, machinery, and other equipment, as opposed to companies that don’t have a lot of physical assets, such as technology companies that work primarily on an idea or service provided online, such as Facebook or Netflix.
These companies mainly have intangible assets, such as intellectual property, which make up most of their value. So, when calculating the book value of companies like this and comparing it to their market value, it is essential to understand why the book value figure is what it is.
With these types of companies, if the book value appears too high or too low relative to a company’s market capitalization, this does not necessarily indicate an overvalued or undervalued security, but rather the fact that the majority of its assets are intangible assets.
The bottom line
Book value is used by investors to get an objective estimate of a company’s value. Book value estimates the true value of everything she owns, minus everything she owes. It consists of the total assets of the company after subtracting the liabilities of the company.
From there, value investors compare book value and its permutation, book value per share, to the company’s stock price. In this way, they determine whether its shares are overvalued or undervalued.
It is important to use book value and book value per share in the right context and with the right stocks. As metrics, they work best on industrial or legacy businesses that own, manufacture, or hold tangible assets, as opposed to information technology or online service providers.
Still, it can be a start in determining a company’s fundamental value — and a good buy.