The book value per share (BVPS) is calculated by taking the ratio of equity available to common stockholders against the number of shares outstanding. When compared to the current market value per share, the book value per share can provide information on how a company’s stock is valued. If the value of BVPS exceeds the market value per share, the company’s stock is deemed undervalued.
The book value is used as an indicator of the value of a company’s stock, and it can be used to predict the possible market price of a share at a given time in the future.
Understanding Book Value Per Share
When calculating the book value per share of a company, we base the calculation on the common stockholders’ equity, and the preferred stock should be excluded from the value of equity. It is because preferred stockholders are ranked higher than common stockholders during liquidation. The BVPS represents the value of equity that remains after paying up all debts and the company’s assets liquidated.
Formula for Book Value Per Share
The formula for calculating the book value per share is given as follows:
N.B.: We used the “average number of shares outstanding” because the closing period amount may skew results if there was a stock issuance or major stock buyouts. Using the period-end amount (which includes short-term events) may provide incorrect results and may mislead investors into thinking that the stock price is overvalued or undervalued when it is not actually the case.
ABC Limited has $20 million of stockholder’s equity, out of which $5 million are preferred stocks. The company has an average of 3 million shares outstanding during the period. Using this information, we can calculate the BVPS as follows:
BVPS = ($20,000,000 – $5,000,000) / 3,000,000
BVPS = $15,000,000 / 3,000,000
BVPS = $5
How to Increase the Book Value Per Share
A company can use the following two methods to increase its book value per share:
1. Repurchase common stocks
One of the main ways of increasing the book value per share is to buy back common stocks from shareholders. Using the previous example, assume that the company repurchases 500,000 common stocks from its shareholders. It will reduce the current shares outstanding to 2.5 million (3,000,000 – 500,000). The revised BVPS will be as follows:
BVPS = $15,000,000 / 2,500,000
BVPS = $6
Repurchasing 500,000 common stocks from the company’s shareholders increases the BVPS from $5 to $6.
2. Increase assets and reduce liabilities
A company can also increase the book value per share by using the generated profits to buy more assets or reduce liabilities. For example, if ABC Limited generates $1 million in earnings during the year and uses $300,000 to purchase more assets for the company, it will increase the common equity, and hence, raise the BVPS.
Similarly, if the company uses $200,000 of the generated revenues to pay up debts and reduce liabilities, it will also increase the equity available to common stockholders.
Market Value Per Share vs. Book Value Per Share
The book value per share and the market value per share are some of the tools used to evaluate the value of a company’s stocks. The market value per share represents the current price of a company’s shares, and it is the price that investors are willing to pay for common stocks. The market value is forward-looking and considers a company’s earning ability in future periods. As the company’s expected growth and profitability increase, the market value per share is expected to increase further.
On the other hand, book value per share is an accounting-based tool that is calculated using historical costs. Unlike the market value per share, the metric is not forward-looking, and it does not reflect the actual market value of a company’s shares.
The BVPS is a conservative way for investors to measure the real value of a company’s stocks, which is done by calculating what stockholders will own when the company liquidates and all debts paid up. Value investors prefer using the BVPS as a gauge of a stock’s potential value when future growth and earnings projections are less stable.
Drawbacks of Book Value Per Share
One of the limitations of book value per share as a valuation method is that it is based on the book value, and it excludes other material factors that can affect the price of a company’s share. For example, intangible factors affect the value of a company’s shares and are left out when calculating the BVPS.
The BVPS only includes the book value of assets (total assets less intangible assets) to show what common stockholders will own if the company was to be liquidated and debts paid up. It means that tech companies, which own very few tangible assets relative to intangible assets such as copyrights and trademarks, may be undervalued because the value of the intangible assets would be excluded when calculating the BVPS.
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