Book value per share
| Book value per share |
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Book value per share is the ratio which represents the number of available common equity divided by the total number of common shares. It shows a book value of each share of stock. In other words, book value is a value of company's net assets, that is: assets minus liabilities.
In case of company liquidation the book value per share is the amount which common equity owners - the shareholders - will receive per share of common stock owned, of course after all the assets would be sold and debtors would be paid. That means that preferred equity is removed from the formula[1].
The formula used to calculate book value per share:
The book value of common equity can be found in the balance sheet which is released regularly by the company, as well as the total number of outstanding shares.
Shareholder equity consists of common equity and preferred equity. The latter means that owners of preferred stock have priority over common shareholders when it comes to receiving dividends, however, in most cases they do not have voting rights while common shareholders do. Preferred stocks share characteristics of both bonds and common stocks and that is why they are excluded from the formula (as not being “true” stocks).
Example
If a company has shareholder equity of 15.500.000 dollars on a given date and the total outstanding shares number is 1.000.000 on that date, the book value per share of that company is 15.5 dollars (assuming it does not have any preferred stocks).
The book value per share can be used by investors to determine what is the relationship between it and market value per share. The market value per share is current price of stock and it represents how much the market participants perceive common share of the stock is worth. By doing so, they can determine and decide whether company stock is undervalued or overvalued. If a book value per share of a company is higher than market value per share (being the current price of the stock on the market) then the stock is undervalued. In that situation it is an attractive stock to buy [2]. The decrease in book value per share means that the stock's market value should go down too, and if it increases, the stock price should increase too.
The main drawback of book value per share is that it is based on historical data from the last balance sheet release period. Whereas, the market value per share is based on current situation and market's perception of the company's stock price and value. Also, the market value per share is market's collective forecast of the stock future performance - it is based on the perceived probable future growth of the company. For example, an expected profitability or some information providing news about potential increase in profits of the company may drive the price of share of the stock. Also, because the book value per share is calculated based on balance sheet reported by the company, the fixed (noncurrent) assets are being reported at their original cost with their accumulated depreciation and amortization taken into account. As a result of that, a difference between book value per share and market value per share might occur.
The book value per share is one of the most popular methods for measuring the value of a company. Some of other metrics include market value or market cap (capitalization). In concept, book value per share is similar to net worth of company, because it shows the relationship between assets and liabilities [3]. It is an information which shows what would happen if a company would sell all of its assets in that moment. However, book value per share based on data from company's balance sheet may not be as accurate as it seems, because some of the assets values are only estimations and accuracy of the approximations may vary.
Book value per share is an important metric for investors to evaluate the value of a company’s stock. It can be used as a comparison to the current market price of the stock to get an idea of whether the stock is undervalued or overvalued. The following are some of the advantages of book value per share:
- It is an easy to calculate metric that gives a simplified view of the company’s net worth.
- It is an important factor in determining the value of a company's assets and liabilities.
- It is a good indicator of a company's financial health, as it can be used to compare the company's current market value to its book value.
- It can be used to measure the performance of a company over time and to compare it to other companies in the same industry.
- It is a useful tool for investors to assess the value of a stock and make informed decisions.
Book value per share is a useful tool for analyzing a company's worth, however, there are some limitations to consider. These include:
- It does not take into account the current market value of the company's assets, which may be higher or lower than the book value. This means the book value may not provide an accurate picture of the company's actual worth.
- It does not take into account the intangible assets of the company such as patents, brand, and customer loyalty. These assets are not reflected in the book value.
- It does not factor in future potential of the company, such as any new products or services it may develop. The book value is based solely on the current assets of the company.
- It can be distorted by accounting policies, such as when a company chooses to write off certain assets at a certain value. This can lead to a lower book value than what could be achieved in the market.
- It does not take into account the company's debt or cash flow. These are both important factors in determining the true value of a company.
Book value per share is a measure of the equity of a company. While the book value is the main measurement of a company’s equity, there are other approaches which investors and analysts use to evaluate a company’s equity such as:
- Price-to-Book Ratio (P/B ratio): This ratio is calculated by dividing the current market price of a company’s share by its book value per share. It is used to compare the market value of a company to its book value.
- Tangible Book Value: This measure is used to evaluate the actual worth of a company’s assets. It is calculated by subtracting intangible assets such as goodwill from the book value.
- Price-to-Tangible Book Ratio (P/TB ratio): This ratio is calculated by dividing the current market price of a company’s share by its tangible book value per share. It is used to compare the market value of a company to its tangible book value.
In summary, Book Value per share is the main measurement of a company’s equity, but there are other approaches such as the Price-to-Book Ratio, Tangible Book Value, and Price-to-Tangible Book Ratio, which can be used to evaluate the value of a company’s assets.
References
- Bini, Ma. & Penman, S. (2013) Companies with market value below book value are more common in Europe than in the US: evidence, explanations and implications, KPMG's Global Valuation Institute
- Penman, S. H., & Penman, S. H. (2007). Financial statement analysis and security valuation New York: McGraw-Hill, p. 476
- Warrad, L., H. (2017) The Effect of Market Valuation Measures on Stock Price, Accounting Department, Applied Science Private University, Amman, 8(3)
- Ahmadi, A. (2017) The stock price valuation of earnings per share and book value: evidence from Tunisian firms, Journal of Internet Banking and Commerce, 22(1)
Footnotes
Author: Klaudia Trybuła
