What Is Book Value?
Book value is equal to the cost of carrying an asset on a company’s balance sheet, and firms calculate it by netting the asset against its accumulated depreciation. As a result, book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities.
For the initial outlay of an investment, book value may be net or gross of expenses such as trading costs, sales taxes, service charges, and so on.
The formula for calculating book value per share (BVPS) is the total common stockholders’ equity less the preferred stock, divided by the number of common shares of the company. Book value may also be known as “net book value” and, in the United Kingdom, “net asset value of a firm.”
- The book value of a company is the net difference between that company’s total assets and total liabilities, where book value reflects the total value of a company’s assets that shareholders of that company would receive if the company were to be liquidated.
- An asset’s book value is equivalent to its carrying value on the balance sheet.
- Book value is often lower than a company’s or asset’s market value.
- Book value per share (BVPS) and price-to-book (P/B) ratio are utilized in fundamental analysis.
Understanding Book Value
Understanding Book Value
Book value is the accounting value of the company’s assets less all claims senior to common equity (such as the company’s liabilities). The term “book value” derives from the accounting practice of recording asset value at the original historical cost in the books.
While the book value of an asset may stay the same over time by accounting measurements, the book value of a company collectively can grow from the accumulation of earnings generated through asset use. Since a company’s book value represents the shareholding worth, comparing book value with the market value of the shares can serve as an effective valuation technique when trying to decide whether shares are fairly priced.
As the accounting value of a firm, book value has two main uses:
- It serves as the total value of the company’s assets that shareholders would theoretically receive if a company was liquidated.
- When compared to the company’s market value, book value can indicate whether a stock is underpriced or overpriced.
Book Value per Share (BVPS)
Book value per share (BVPS) is a method to calculate the per-share book value of a company based on common shareholders’ equity in the company. Should the company dissolve, the book value per common share indicates the dollar value remaining for common shareholders after all assets are liquidated and all debtors are paid. If a company’s BVPS is higher than its market value per share, then its stock may be considered to be undervalued.
In personal finance, the book value of an investment is the price paid for a security or debt investment. When a company sells stock, the selling price minus the book value is the capital gain or loss from the investment.
Mark to Market Valuation
There are limitations to how accurately book value can be a proxy to the shares’ market worth when mark to market valuation is not applied to assets that may experience increases or decreases of their market values.
For example, real estate owned by a company may gain in market value at times, while its old machinery can lose value in the market because of technological advancements. In these instances, book value at the historical cost would distort an asset or a company’s true value, given its fair market price.
Price-to-Book (P/B) Ratio
Price-to-book (P/B) ratio as a valuation multiple is useful for value comparison between similar companies within the same industry when they follow a uniform accounting method for asset valuation. The ratio may not serve as a valid valuation basis when comparing companies from different sectors and industries, whereby some companies may record their assets at historical costs and others mark their assets to market.
As a result, a high P/B ratio would not necessarily be a premium valuation, and conversely, a low P/B ratio would not automatically be a discount valuation.
Why is it called ‘book value’?
Book value gets its name from accounting lingo where the balance sheet is known as a company’s “books.” In fact, accounting was once called bookkeeping. Thus, book value can be equated with accounting value.
What does a price-to-book (P/B) ratio of 1.0 mean?
A P/B ratio of 1.0 indicates that the market price of a company’s shares is exactly equal to its book value. For value investors, this may signal a good buy, since the market price of a company generally carries some premium over book value.
Why is market value often higher than book value?
Book value only considers the cost to liquidate a firm’s fixed assets and securities. It does not consider intangible assets such as patents, intellectual property, brand value, and goodwill. It also does not account for workers’ skills and human capital. Moreover, it doesn’t account for how a firm’s assets will generate profits and growth over time. Therefore, the market value, which takes into consideration all of these things, will generally be higher.
The Bottom Line
Book value is the accounting value of a company’s assets less liabilities. In other words, it is the expected value that a firm can expect if it were to sell all of the assets on its balance sheet and cover its outstanding debts and obligations.
A company’s market value will usually be greater than its book value since the market price incorporates intangible assets such as intellectual property, human capital, and future growth prospects. Value investors look for companies with relatively low book values (using metrics like P/B ratio or BVPS) but otherwise strong fundamentals as potentially underpriced stocks in which to invest.