What is Book Value?
Book value is a company’s equity value as reported in its financial statements. The book value figure is typically viewed in relation to the company’s stock value (market capitalization) and is determined by taking the total value of a company’s assets and subtracting any of the liabilities the company still owes.
Below is the Book Value Formula:
The company’s balance sheet also makes room for any depreciation in the value of assets. It enables the book value to be a closer match to the real or actual value of the company. Book value is typically given for each share, determined by dividing all shareholder equity by the number of common stock shares that are still outstanding.
Importance of Book Value
Book value is considered important in terms of valuation because it represents a fair and accurate picture of a company’s worth. The figure is determined using factual company data and isn’t typically a subjective figure. It means that investors and market analysts get a reasonable idea of the company’s actual worth.
Book value is primarily important for investors using a value investing strategy because it can enable them to find bargain deals on stocks, especially if they suspect that the company is undervalued and/or is poised to grow, and the stocks are going to rise in price.
Stocks that trade below book value are often considered a steal because they are anticipated to turn around and trade higher. Investors who can grab the stocks while costs are low in relation to the company’s book value are in an ideal position to make a substantial profit and be in a good trading position down the road.
The Issue of Intangibles
The book value’s inescapable flaw is the fact that it doesn’t accurately account for intangible things of value within a company, which includes items such as patents and intellectual property. What does it mean for investors? It means they need to be wise and observant, taking the type of company and the industry it operates in under consideration.
For example, consider a value investor who is looking at the stock of a company that designs and sells apps. Because it is a technology company, a major portion of the company’s value is rooted in the ideas for, and rights to create, the apps it markets.
The company could be trading much higher than its book value because the market’s valuation takes into account the company’s intangible assets, such as intellectual property. The stock, then, isn’t really overpriced – its book value is lower simply because it doesn’t accurately account for all the aspects of value that the company holds.
Book value is a widely-used financial metric for determining a company’s value and whether its stock price is over- or under-appreciated. It’s wise for investors and traders to pay close attention, however, to the nature of the company and other assets that may not be well represented in the book value.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: