What is Book Value?
An asset's book value is equal to its carrying value on the balance sheet, and companies calculate it netting the asset against its accumulated depreciation. Book value is also the net asset value of a company calculated as 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.
Understanding Book Value
Breaking Down Book Value
Book value is also known as "net book value" and, in the U.K., "net asset value."
As the accounting value of a firm, book value has two main uses:
1. It serves as the total value of the company's assets that shareholders would theoretically receive if a company were liquidated.
2. When compared to the company's market value, book value can indicate whether a stock is under- or overpriced.
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.
For more information, check out Digging Into Book Value.
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 market value of the shares can serve as an effective valuation technique when trying to decide whether shares are fairly priced.
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 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.