Book value is a financial measure of a business and a tool that helps investors determine if its stock is a good deal.
The book value of a business is the total value of all of its assets minus all of its liabilities.
Investors compare a company’s book value to its stock price, to judge whether stocks are undervalued or overvalued.
Book value works best on durable goods companies, compared to service providers or companies with intangibles.
- Visit the Business Insider Investment Reference Library for more stories.
When looking for stocks to buy, investors often need to look closely at companies’ financial data. One of the big things they look at is book value.
Book value is a calculation that aims to determine the true and full value of a business, based on its assets. This is essentially the break-up value, which is the amount the company would be worth if it were liquidated.
Investors use book value to help them judge whether a company’s shares are overvalued or undervalued.
Let’s dive deeper into book value, how it’s calculated, and what it means.
What is book value?
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 a piece of equipment. The carrying amount 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 assets of the business – the value of all the goods, properties, funds and other things that it owns –less its liabilities – its expenses and debts. Usually, the value of any intangible asset, 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 break-up value of the business. If the company went bankrupt or was dismantled and sold, that book value would be used to determine what individual shareholders would receive – roughly, the cash value of their individual shares.
How to calculate book value and book value per share
Book value is not often included in a company’s stock listings or online profile. To find its book value, you need to look at its financial statements, and all the assets and liabilities on its balance sheets. Add up all assets, subtract all liabilities and the result is the book value.
When valuing a business, the book value can be calculated as follows:
Carrying amount = Total assets – Intangible assets – Liabilities
What is the book value per share?
Although you have to calculate the book value yourself, most online stock quotes include a related metric that is also useful to investors: Book Value Per Share (BVPS). Book value per share shows how much dollars each share will receive if a company is wound up and its creditors paid.
Expressed as an amount in dollars, BVPS breaks down the overall book value of the company by dividing it by all the outstanding shares of the company, to arrive at an amount per share. This amount can be compared to the current market price of the share.
Some sites also mention this as a single number, called the price-to-book ratio.
For example, at the end of January 2021, Microsoft Corp. (MSFT) had a book value per share of US $ 24.65 and a price to book ratio of 14, compared to a share price of US $ 242.
How investors use book value
Book value, book value per share, and price-to-book ratio are metrics favored by advocates of value investing. This investment strategy boils down to bargain hunting: rather than targeting the best performing stocks, it looks for low priced and overlooked stocks in the hope that their stock price will eventually rise.
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 price of the stock), this may indicate an undervalued stock. If the book value per share is less than its market value per share, it may indicate an overvalued or overvalued stock.
The reasoning for 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 the book value
Book value is best used with companies that have physical assets, such as factories, machinery, and other equipment, as opposed to companies that do not have a lot of physical assets, such as technology companies that operate primarily on an idea or a service provided online, such as Facebook or Netflix.
These companies mainly own intangible assets, such as intellectual property, which constitute the bulk of their value. So, when calculating the book value of businesses like this and comparing them to their market value, it is essential to understand why the book value figure is what it is.
With these type of companies, if the book value appears too high or too low relative to a company’s market capitalization, it does not necessarily indicate an overvalued or undervalued stock, but rather the fact that the major part of its assets are intangible assets.
The financial report
Book value is used by investors to get an objective estimate of the value of a business. Book value estimates the true value of everything it owns, minus everything it owes. It consists of the total assets of the business after subtracting the liabilities of the business.
From there, value-oriented investors compare the book value and its permutation, the book value per share, to the price of the company’s shares. In this way, they determine if its stocks are overvalued or undervalued.
It is important to use book value and book value per share in the right context and with the right titles. As measures, they work best on industrial or legacy businesses that own, manufacture, or hold tangible assets, as opposed to providers of information technology or online services.
Still, it can be a start to determining the core value of a business – and a good buy.