A:

Book value and intrinsic value are two ways to measure the value of a company.

In simple terms, book value is based on the value of total assets less the value of total liabilities - it attempts to measure the net assets a company has built up until the present time. In theory, this is the amount that the shareholders would receive if the company were to be completely liquidated. For example, if a company has $23.2 billion in assets and $19.3 billion in liabilities, the book value of the company would be the difference of $3.9 billion (book value). To express this number in terms of book value per share, simply take the book value and divide it by the number of outstanding shares. If a given company is currently trading below its book value, it is often considered to be undervalued.

There are, however, several problems that arise with the use of book value as a measure of value. For example, it would be unlikely that the value the company would receive in liquidation would be equal to the book value per share. Nevertheless, it can still be used as a useful benchmark to estimate how much a profitable company's stock might drop if the market turns sour on it.

Intrinsic value is a measure of value based on the future earnings a company is expected to generate for its investors - it attempts to measure the total net assets a company is expected to build in the future. It is considered the true value of the company from an investment standpoint and is calculated by taking the present value of the earnings (attributable to investors) that a company is expected to generate in the future, along with the future sale value of the company. The idea behind this measure is that the purchase of a stock entitles the owner to his or her share of the company's future earnings. If all of the future earnings are accurately known along with the final sale price, the company's true value can be calculated.

For example, if we assume that a company will be around for one year and generate $1,000 before being sold for $10,000, we can find the intrinsic value of the company. At the end of the year we will have received $11,000. If our required rate of return is 10%, then the present value today of the future earnings and sale price is $10,000. If we were to pay more than $10,000 for the company, our required rate of return would not be met.

To learn more, check out Value By The Book, A Guide to Stock Picking Strategies and the Ratio Analysis Tutorial.

RELATED FAQS

  1. Is it better to buy A-shares or a no-load mutual fund?

    Understand the difference between Class A mutual funds and no-load funds, and learn which option for mutual fund investing ...
  2. What is the smallest amount of shares I can buy?

    Understand the steps needed for an investor to open a brokerage account and make a trade. Learn what the smallest amount ...
  3. Is Book Value Of Equity Per Share (BVPS) a good metric for long-term value investing?

    Read about how to interpret book value of equity per share, or BVPS, and see whether BVPS is a useful metric for long-term ...
  4. Should I buy and hold a cyclical stock for long-term gains?

    Discover whether cyclical stocks are a good option for long-term investors. Cyclical stocks tend to be highly leveraged to ...
RELATED TERMS
  1. Warren Buffett

    Known as "the Oracle of Omaha", Buffett is Chairman of Berkshire ...
  2. Holding Period Return/Yield

    The total return received from holding an asset or portfolio ...
  3. Unloved Stock

    A stock that is out of favor with investors. The term unloved ...
  4. Buyers/Sellers On Balance

    1. A ratio based on aggregate market orders for securities that ...
  5. Graham Number

    A figure that measures a stock's fundamental value by taking ...
  6. Index Investing

    A form of passive investing that aims to generate the same rate ...

You May Also Like

Related Articles
  1. Investing Basics

    Four Buy and Hold Stocks for Millennials

  2. Economics

    Buy and Hold: Comfortable, But Mind ...

  3. Trading Strategies

    Market Timing Tips & Rules You Should ...

  4. Investing

    What Is The Real Picture Of Linn Energy?

  5. Active Trading

    Warren Buffett: How He Does It

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!