Book Value

A company's book value is equal to its total assets less its outstanding liabilities. After liquidating all of its tangible assets and paying off all of its liabilities, it indicates the total amount of equity it would be worth to its shareholders. 

The cost of carrying an asset on a company's balance sheet is equal to its BV, which is calculated by netting the item against its cumulative depreciation. As a result, it can also be thought of as a company's net asset value (NAV), which is derived by subtracting total assets from intangible assets (patents, goodwill), as well as liabilities. 

It may be net or gross expenses such as trading fees, sales taxes, service charges, and so on for the initial outlay of investment. It is generally represented as BV per share and is important for determining a company's value. 

Book Value per share = (Shareholders' equity - preferred stock)/ Number of common shares in the corporation

It is also known as "net book value" and "net asset worth of a corporation" in the United Kingdom. BV can also be referred to as "carrying value."

The term "book value" comes from accounting jargon, where the balance sheet is referred to as a company's "books." Accounting was originally known as bookkeeping and as a result, it and accounting value are interchangeable.

Understanding the BV

The accounted value of a company's assets less all claims senior to common stock (such as liabilities) equals BV. The phrase "BV" comes from the accounting practice of recording asset value in the books at its original historical cost.

While the value of an asset may remain constant over time due to accounting calculations, the BV of a company as a whole might increase due to the accumulation of earnings created through asset utilization. 

Because a company's BV indicates the value of its shareholdings, comparing value to market value can be a useful valuation approach when determining if shares are fairly priced.

It serves the following purposes as a company's accounting value:

• It represents the total worth of the firm's assets that shareholders would get if the company were to be liquidated.
• When compared to a company's market value, BV can reveal whether a stock is overpriced or underpriced.
• Trying to figure out if a stock is undervalued or overvalued (to understand if they should buy, sell, or hold).
• Comparing numerous companies or stocks in a market analysis.
• Understanding working capital is essential.
• Financial ratios are calculated for fundamental analysis. Some examples are
  • The ratio of working capital
  • The ratio of debt to equity
  • Debt-to-income ratio
  • P/B (price to book) ratio
  • current proportion

Importance

In terms of valuation, the value is significant since it provides a fair and true view of a company's worth. The value is calculated based on historical company data and is not subjective. 

Investors and market experts an increased sense of how much the company is worth by using the BV value

For investors who employ a value investing strategy, it is essential because it can help them uncover bargain stock buys, especially if they believe a firm is undervalued and/or positioned to grow and the stock will climb in price.

Stocks that trade below BV are sometimes regarded as bargains since they are expected to rise in value. Investors who can purchase stocks at a low cost relative to the company's value are in a great position to profit and create a solid trading position in the future.

Price to book value (P/B) is the most effective valuation measure in determining a stock's performance, according to multiple research studies. This financial metric compares a company's current market value against it with the equation below,

P/B = Market Price per Share / Book Value per Share

Buying at low price-to-book multiples leads to superior returns, even though the price-earnings ratio (P/E) is far more popular. The theoretical value of a company's net assets is called BV.

Why Do Investors Care About it?

The foundations of any public company's financial statements are earnings, debt, and assets. Companies distill these three aspects down into more precise data for investors to evaluate for disclosure. 

Investors can use these to generate valuation ratios, making it easier to compare companies. The book value and the price-to-book ratio (P/B ratio) are two of the most important metrics for value investors.

Investors value it because it gives them an overview of a company's complete worth. This data can be used for a variety of purposes:

1. Identifying whether a stock is undervalued or overvalued is a difficult task (to understand if they should buy, sell, or hold).
2. Comparing numerous companies or stocks in a market analysis.
3. Understanding the concept of working capital.

For fundamental analysis, financial ratios are calculated. Here are several examples:

• The ratio of working capital
• The ratio of debt to equity
• Debt-to-income ratio
• P/B (price-to-book) ratio
• The current ratio

The Issue of Intangibles

The fact that BV does not adequately account for intangible assets of value within a corporation, such as patents and intellectual property, is an unavoidable shortcoming. What does this imply for financial investors? 

It implies they must be wise and vigilant, taking into account the type of business and the industry in which it operates.

Consider the case of a value investor interested in the stock of a firm that develops and sells apps. Because it is a technological company, a significant chunk of its worth is based on the ideas for the apps it sells and the rights to produce them.

Because the market considers the company's intangible assets, such as intellectual property, the stock could be trading significantly higher than its BV. 

As a result, the stock isn't expensive in reality; its value is lower merely because it doesn't fully account for or take all aspects of value for all of the company's assets.
Per-Share Book Value (BVPS)

Per-Share Book Value (BVPS)

BVPS is a method for calculating a company's BVPS based on common shareholders' equity.

The BVPS reflects the monetary value left for common shareholders after all assets are liquidated and all debtors are paid if the company dissolves. 

A company's stock may be considered undervalued if its BVPS is higher than its market value per share.

The BV of an investment is the amount paid for a securities or debt investment in personal finance. The capital gain or loss on an investment is calculated by subtracting the selling price from the value when a company sells the stock.

Price-to-Book Ratio

When companies in the same industry utilize a uniform accounting technique for asset valuation, the price-to-book (P/B) ratio as a valuation multiple is useful for comparing value amongst them. 

When comparing companies from different sectors and industries, the ratio may not be a viable valuation technique because some companies may register their assets at historical costs while others mark their assets to market.

As a result, a high P/B ratio does not automatically imply a premium valuation, and a low P/B ratio does not imply a discount value.

What Does a 1.0 Price-to-Book Ratio Indicate?

The market price of a company's shares is exactly equal to its book value when the P/B ratio is 1.0. This could be an excellent investment for value investors because a company's market price is usually higher than its value.

Why is it that the market value of a property is frequently higher than the BV?

Only the cost of liquidating a company's fixed assets and securities is considered in this equation. Intangible assets such as patents, intellectual property, brand value, and goodwill are not taken into account. 

It also fails to take into consideration workers' abilities and human capital. Furthermore, it ignores how a company's assets will generate revenues and growth over time.

As a result, the market value, which takes all of these factors into account, will normally be higher.

Limitations

Despite its many advantages, it has certain drawbacks:

1. Not Always Current

In most cases, balance sheets are published regularly or annually. Investors must rely on the most recent numbers between reports, which often fluctuate from month to month.

2. Complexity is a possibility

Adjustments (such as depreciation) must be taken into account in order to obtain an appropriate BV. There are a variety of depreciation methodologies, accounting rules, and other factors that might complicate computations.

3. Intangibles are not included in this calculation

One of the most significant disadvantages of it is that it ignores intangibles such as intellectual property and branding. It's significantly more difficult to assess companies that rely substantially on human capital and intangible assets.

4. Growth Is Ignored

Assets and liabilities do not necessarily provide a complete picture. Low or negative value might result from companies that invest extensively in development or willingly operate at a loss. 

If the price-to-book ratio is calculated using that figure, the ratio may (incorrectly) indicate that the company is undervalued or in crisis.

5. Does not Account for Quality

The quality of a company's assets or its current market price is not taken into account when calculating it. Assets (such as real estate) may appreciate in value over time, whereas machinery and equipment may become obsolete or unreliable.

In both cases, the BV of the assets may not adequately reflect their worth.

How to Work Out Your Book Value

Subtract the asset's cumulative depreciation from its original cost to arrive at its BV.

You deduct the value of a company's total liabilities and intangible assets from the value of its total assets to get its value.

BV Formula

Of an asset:

Book value = original cost - accumulated depreciation

Of a company:

Book value = total assets - total liabilities

Formula of total assets

Total assets = non-current assets + current assets

Formula to total liabilities

Total liabilities= non-current liabilities + current liabilities

Formula for BVPS (book value per share)

Divide common shareholders' equity by the total number of outstanding shares to get the BVPS.

BVPS = (Shareholder's Equity - Preferred Shares)/ Total Number of Outstanding Shares

Total Outstanding Shares = Total Number of Shares Issued − Shares as Treasury Stock

Difference between fair value and book value, salvage value, and BV

Fair Value vs. Book Value

Both are used to appraise an asset, however, there is a distinction in how the price is determined:

The carrying value of an asset is its initial cost minus any depreciation, amortization, or impairment charges. It's an estimate of how much the asset is worth on the balance sheet, but it doesn't always correspond to the real selling price.

The price agreed upon between buyer and seller determines fair value, which is a reasonable assessment of the asset's potential market value.

Salvage Value vs. Book Value

The BV of an asset at the end of its useful life, after it has been fully depreciated, is known as salvage value.

The words refer to the worth of an asset on a balance sheet after depreciation. There is, however, one significant distinction between book value and salvage value:

The value of an asset on a balance sheet is reported as book value (or carrying value), which is adjusted for depreciation.

Researched and authored by Deeksha Pachauri | LinkedIn

Edited by Colt DiGiovanni | LinkedIn

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources:

• LIFO vs. FIFO
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• Operating Cycle
• Operating Expenses