How to calculate book value
Book value is the difference between a company's total aggregate assets and liabilities. Here, assets include all the fixed and current assets, and liabilities include current and non-current liabilities.
The formula to calculate book value is:
Book value: Total assets - Total liabilities
In some cases, financial analysts exclude the intangible assets while calculating the book value since the book value of intangible assets can not be determined during the company's liquidation process. In such a case, the formula for book value changes to:
Book value: Total assets - (Intangible assets + Total liabilities)
Here is an example with the balance sheet of Company ‘A’ for calculating the book value:
Assets
|
Amount (In Rs.)
|
Current assets
|
|
Cash and cash equivalents
|
Rs. 50,000
|
Accounts receivable
|
Rs. 30,000
|
Inventory
|
Rs. 20,000
|
Total current assets
|
Rs. 1,00,000
|
Non-current assets
|
|
Property, Plant, and Equipment
|
Rs. 2,00,000
|
Intangible assets (Goodwill, etc.)
|
Rs. 50,000
|
Total non-current assets
|
Rs. 2,50,000
|
Total assets
|
Rs. 3,50,000
|
Liabilities and equity
|
|
Current liabilities
|
|
Accounts payable
|
Rs. 40,000
|
Short-term debt
|
Rs. 20,000
|
Total current liabilities
|
Rs. 60,000
|
Non-current liabilities
|
|
Long-term debt
|
Rs. 1,00,000
|
Total non-current liabilities
|
Rs. 1,00,000
|
Total liabilities
|
Rs. 1,60,000
|
Equity
|
|
Common stock
|
Rs. 50,000
|
Retained earnings
|
Rs. 1,40,000
|
Total equity
|
Rs. 1,90,000
|
Total liabilities and equity
|
Rs. 3,50,000
|
Calculation of book value:
Book value: Total assets - Total liabilities
Book value: Rs. 3,50,000 - Rs. 1,60,000 = Rs. 1,90,000
Hence, the book value for company ‘A’ is Rs. 1,90,000
What are the measures of book value
Subtracting a company’s total liabilities from its assets provides only a rough estimate of its actual value. For a more in-depth assessment, investors tend to adopt different metrics to arrive as close to the real booking value of a company as possible. One such approach is calculating the Book Value of Equity Per Share (BVPS).
Book value per share (BVPS):
Book value per share is a metric of book value where the net value of a listed company’s asset (shareholder equity) is taken and divided by the total number of outstanding shares. It is one of the most used metrics by investors who want to know their amount of earnings in case the company liquidates.
For example, the company ‘A’ has 10,000 outstanding shares, and its shareholder equity is Rs. 1,90,000. In this case, BVPS will be calculated as:
BVPS = Net value of assets or shareholders' equity / total number of outstanding shares.
BVPS = Rs. 1,90,000 / 10,000 = Rs. 19 per share
Thus, company A's book value per share is Rs. 19 per share.
While this certainly looks promising, it does not reflect the complete picture. For a more comprehensive understanding of XYZ’s potential, investors will need to employ other metrics in tandem with the BVPS. Another such metric is the price-to-book-value (P/B) ratio, more popularly known as the price-to-equity ratio.
Price-to-book ratio:
The Price-to-Book (P/B) value ratio is a financial metric that compares a company's market value to its book value. Hence, P/B ratio is also derived from the book value of the company. It is used to assess whether a stock is overvalued or undervalued by comparing the market's valuation of a company to its book value as reported on its balance sheet.
Formula: Market price per share/book value per share (BVPS)
For example, company ‘A’ has a BVPS of Rs. 19, and the market price per share is Rs. 38. In this case, the P/B ratio will be calculated as:
P/B ratio: Market price per share/book value per share (BVPS)
P/B ratio: Rs. 38/Rs. 19 = 2
Thus, the P/B ratio for Company ‘A’ is 2.
Significance
Book value is very important for investors to understand whether the share price of a company’s stock is justified. Hence, value investors who invest for the long term base their investments on extensively analysing a company's book value. Such investors look for companies with a high book value as they are viewed as safer investments. This is because companies with a high book value possess significant tangible assets that can be liquidated if necessary. Furthermore, investors take book value metrics such as BVPS and P/B ratio for analysis.
Investors use the P/B ratio to compare the company's market value to its book value, helping them determine whether the stock is overvalued or undervalued. If the stock is overvalued, investors book profits and reduce their holdings. On the other hand, if the stock is undervalued, value investors invest in it for profits based on the increase in its price in the future. A P/B ratio of 1 indicates the stock is undervalued, while a P/B ratio above 1 indicates that the stock may be overvalued.
Furthermore, using BVPS can help investors assess whether a stock is fairly valued, overvalued, or undervalued in the market. For example, suppose a company's BVPS is lower than its market price per share. In that case, the stock is overvalued unless the company has significant intangible assets or growth potential, justifying a higher market price. On the other hand, if the BVPS is close to or above the current market price, the stock might be undervalued, indicating a potential buying opportunity.
Importance
From a value investing standpoint, book value holds enormous weight. As an investment strategy, value investing looks beyond what a company’s balance sheet is showing. Focusing on stocks that are undervalued or underpriced, value investors make use of the book value of a company to understand its true position in the market.
If an investor is able to identify companies that are performing noticeably better than what their revenues are showing, and if such companies’ stocks are being traded below their book value, then that investor is poised to make huge profits by buying these stocks. For instance, if a company’s P/B ratio is below 1, it means that its stock is underpriced, indicating that its book value is higher than its market cap. On the other hand, if the ratio is more than 1, it indicates that its market cap is higher than its book value and its stock is, therefore, overvalued.
Book value enables investors to understand the gap between what a company’s revenue data is showing and how the company is being perceived by the market.
Limitations of book value
- Periodic publishing
Book value data is only updated in quarterly or annual balance sheets, leaving investors with outdated information between reporting periods. This gap can result in decisions based on outdated figures.
- Historical costing
Conventional accounting records assets at historical cost, not accounting for real-time depreciation or appreciation. This creates discrepancies in book value, as it may not reflect the current market worth of the assets.
- Inaccuracy for human-intensive companies
For companies heavily reliant on human capital, book value may undervalue the organisation’s true worth, as financial statements may not adequately capture intangible assets like skilled employees or intellectual property.
Book value vs market value
There are substantial differences between the book value and the market value of a company. A company’s book value showcases a company’s total worth based on its financial statement and performance. On the other hand, the market value is a company's worth based on its perceived value by the market.
When the market value is higher than the book value of a company’s stock, it means that the market takes the company as one with growth potential capable of creating value. However, if the book value of a company is higher than its market value, it indicates that the market and the investors are less confident in the company’s growth potential, even when the book value is high.
Hence, it is important that you analyse both the book and the market value to decide where a company’s stock is worth investing in.
Conclusion
Booking value is an extremely useful tool for investors to estimate a company’s position in the market in a holistic manner and make informed investment decisions. For companies, publishing accurate financial information is critical if they intend to grow, expand, and attract long-term value investments. However, investors need to analyse the book value in conjunction with other information about a company before investing in it.
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