Investors and creditors have several measurements for determining the valuation of a company's stock and whether the stock is fairly valued, overvalued or undervalued. Creditors are interested in the company's asset value to determine how much to lend since assets are typically used as collateral for loans or determine a company's ability to pay back the loan.

Investors are concerned with a company's assets as they compare to its liabilities or book value, but also to the company's stock price or market value. Book value is the value of a company according to its balance sheet, or "books." Market value is the value of the company in the eyes of the stock market. These are two fundamentally different calculations that tell a story about the company's overall financial strength. In this article, we'll explore the differences between book value and market value and how they're used in analyzing stocks for investment.

## Book Value

Book value literally means the value of the business according to its "books" or financial statements. In this case, book value is calculated from the balance sheet, and it’s the difference between a company's total assets and total liabilities. On the company's balance sheet, book value is recorded as shareholders' equity.

For example, if Company XYZ has total assets of \$100 million and total liabilities of \$80 million, the book value of the company is \$20 million. In a very broad sense, this means that if the company sold off its assets and paid down its liabilities, the equity value or net worth of the business would be \$20 million.

For fundamental and value investors, book value is important to consider because a company with a higher book value than market value may indicate a buying opportunity. A stock might be considered undervalued if its book value exceeds the market value, since it would be viewed by the market that the stock is trading at a cheaper price than the actual value of the company. As a result, value investors might buy the stock based on the lower market valuation with the expectation that the market will eventually catch up to the cheap valuation ultimately sending the stock price higher.

## Market Value

Market value is the value of a company according to the stock market. Market value is calculated by multiplying a company's shares outstanding by its current market price. This is also known as market capitalization.

If Company XYZ has 1 million shares outstanding, and each share trades for \$50, then the company's market value is \$50 million. Market value is most often the number analysts, newspapers and investors refer to when they mention the value of a company.

## How to Read Book Value and Market Value

Book value measures the value of the company on its books, often referred to as accounting value. It's the accounting value once assets and liabilities have been accounted for by a company's auditors. Whether market value is an accurate assessment of a company's value is determined by stock market investors who buy and sell the stock. Market value has a more meaningful implication in the sense that it’s the price you have to pay to own a part of the business regardless of the company’s stated book value.

As you can see from our fictitious example, Company XYZ from above, market value and book value differed substantially. In the financial markets, you will find that book value and market value differ the vast majority of the time. The difference can depend on various factors such as the company's industry, the nature of a company's assets and liabilities, and the company's specific attributes. Companies like those included on the Dow Jones Industrial Average (DJIA) usually have a higher market value than book value.

## 3 Outcomes When Comparing Book Value and Market Value

1. Book value greater than market value. When the market value a company is trading for less than its stated value or book value, it's usually because the market has lost confidence in the company. In other words, the market doesn't believe that the company is worth the value on its books or that there are enough assets to generate future profits and cash flows. Value investors often like to seek out companies in this category in hopes that the market perception turns out to be incorrect. In this scenario, the market is giving investors an opportunity to buy a company for less than its stated net worth, meaning the stock price is lower than the company's book value.
2. Market value greater than book value. When the market value exceeds the book value, the stock market is assigning a higher value to the company due to the earnings power of the company's assets. Consistently profitable companies typically have market values greater than book values.

If a share’s market value is significantly higher than its book value per common share, this usually indicates investors believe the company has excellent future prospects for growth, expansion and increased profits that eventually raise the book value of the company. They may also believe the value of the company is higher than the current book value calculation shows. In other words, the book value is inaccurate.

If investors are mistaken in their assessment of the company, a substantially higher market value might mean the stock is overvalued and will most likely fall in price as investors eventually realize their expectations for the stock had been overly optimistic. However, a stock with a market price substantially higher than its indicated book value may be appealing to growth investors. Value investors, on the other hand, are likely to shy away from it as they prefer to invest in stocks they believe are undervalued.

3. Book value equals market value. The market sees no compelling reason to believe the company's assets are better or worse than what is stated on the balance sheet.

## Price-to-Book Ratio

It's important to note that on any given day, a company's market value will fluctuate in relation to book value. The metric that tells this is known as the price-to-book ratio, or the P/B ratio:

P/B Ratio = Share Price / Book Value Per Share (where Book Value Per Share equals shareholders' equity divided by the number of shares outstanding).

For example, let's say, a company has a P/B of 1, meaning that BV and MV are equal. The next day, the market price drops and the P/B ratio is less than 1, meaning market value is less than book value. The following day the market price zooms higher and creates a P/B ratio of greater than 1, meaning market value now exceeds book value.

To an investor, whether the P/B ratio is 0.95, 1 or 1.1, the underlying stock is trading at nearly book value. In other words, P/B becomes more meaningful the greater the number differs from 1. To a value-seeking investor, a company that trades for a P/B ratio of 0.5 is attractive because it implies that the market value is one-half of the company's stated book value. In other words, the market is offering the stock \$1 of net assets (net assets = assets - liabilities) for 50 cents.

## Which Value Offers More Value?

So which metric – book value or market value – is more reliable? That depends. Understanding why is made easier by looking at some well-known companies.

### Coca-Cola Co. (KO)

The Coca-Cola Co. has historically traded at a P/B ratio of 4 to 5. This means that Coca-Cola's market value has typically been 4 to 5 times larger than the stated book value as seen on the balance sheet. In other words, the stock market values the firm's business as being significantly worth more than the company's value on its books. In looking at Coca-Cola's income statement, we can see why. Coca-Cola is typically a very profitable company. Its net profit margin typically exceeds 16%.

In other words, it makes at least 16 cents of profit from each dollar of sales. The takeaway is that Coca-Cola has valuable assets, brands, distribution channels, and beverages that allow the company to earn a profit. The high P/B ratio tells us that the stock market views Coca-Cola's assets as so valuable, that the market value of the stock trades at a premium to the assets on their books.

Another reason the financial markets might assign a higher market value than the stated book value to a company is that the book value is not necessarily an accurate measure of a company's net worth. Book value is an accounting value, which is subject to many rules like depreciation that require companies to write down the value of certain assets. But if those assets are consistently generating greater profit, then the market understands that those assets are really worth more than what the accounting rules dictate. For example, many high-quality companies like Johnson & Johnson (JNJ), PepsiCo Inc. (PEP), and Procter & Gamble Co. (PG) typically possess market values far greater than book values.

### Wells Fargo & Co. (WFC)

Wells Fargo is one of the oldest and largest banks in the U.S. It typically trades for a P/B of roughly 1.5 meaning the market values Wells Fargo at or close to its book value. The reason for the low P/B for Wells Fargo has to do with the bank's industry. Financial companies hold assets that consist of loans, investments, cash and other financial securities. Since these assets are made of dollars, it's easy to value them: A dollar is worth a dollar.

Of course, we know that some financial assets are better than others; for example, a good loan is better than a bad loan. A good loan is one that is paid in full, and the bank recoups 100 cents on the dollar. A bad loan can stick the bank with a loss and recoup 50 cents on the dollar. That's why whenever banks experience a financial crisis, as in the case of the subprime meltdown in 2008, their market values fall below their book values. In other words, the financial markets lose faith in the value of those assets.

Some financial institutions like American Express Co. (AXP), which have a long history of extending out good credit, typically trade at a modest premium to book value. On the other hand, banks that have made consistently bad credit decisions typically trade below book. But in general, bank stocks do not typically trade for higher multiples to their book values as seen with Coca-Cola because of the nature of their assets.

## When the Values Matter

To determine how book value relates to market value, look at the income generated by the company's assets. A company that can generate a relatively high income from its assets will typically possess a market value that's far higher than its book value. This is called the company's return on assets, or ROA. Coca-Cola's ROA is typically around 7% to 8%. This means each dollar of Coke's assets generates 7 to 8 cents of profit.

Wells Fargo has an ROA of 1% to 2%, earning 1 to 2 cents from each dollar of assets. Because Coca-Cola's assets generate more profit per dollar, its assets will be valued much higher in the marketplace. What this also means is that in the case of companies like Coca-Cola, book value is not as meaningful as it would be for a company like Wells Fargo. For more on ROA, please read "What Is the Formula for Calculating Return on Assets (ROA)?"

There are other ways to calculate and analyze book value. The book value per common share, or BVPS, is a tool of financial measurement for the minimum per share value of a company’s equity. For a more in-depth look at calculating book value per share, please read "Digging Into Book Value."

## The Bottom Line

Comparing the book value to the market value of a company can help investors determine whether a stock is overvalued or undervalued given its assets, liabilities and its ability to generate income. However, with any financial metric, the real utility comes from recognizing the advantages and limitations of book value and market value. An investor must determine when the book value or market value should be used, and when it should be discounted or disregarded in favor of other meaningful parameters when analyzing a company.

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