The book value of a company represents the net asset value (total assets – total liabilities) of a company. Mathematically, it is the sum of all the tangible assets, i.e., equipment and property owned by the company, cash holdings, inventory on hand minus all liabilities.
Book Value Per Share or BVPS is used by investors to determine if a company’s stock price is undervalued compared to its market value per share.
In today’s blog, we deep dive into what is book value of a share, what it indicates, and its role for investors.
This article covers:
- What is book value?
- What is book value per share?
- What does book value per share tell investors?
- Market value vs. Book value
- Components of book value per share
- Calculation of book value per share
- How do companies increase the book value per share?
- What does book value per share denote and its importance in analysis?
- Should you worry about book value per share as an investor?
What is book value?
In simple words, book value is the sum available for shareholders in case a company gets liquidated. Since preferred stock owners carry priority right to claim on assets and earnings over common shareholders, preferred stock is deducted from book value to know the equity value available to common shareholders.
What is book value per share?
Book value per equity share indicates a firm’s net asset value on a per-share basis. It represents the accounting value of a share of a listed company. It assesses the minimum value of a company’s equity share.
What does book value per share tell investors?
Book value per share is an important metric that investors use to evaluate the value of stocks. It helps investors to find undervalued/overvalued stocks. A stock is considered undervalued if the book value per share is more than the price at which it trades in the market.
Market value vs. Book value
Market value per share and book value per share are both metrics used to gauge the value of a stock but are different assessments. Book value per share considers historical costs, whereas the market value per share is based on the company’s potential profitability. Market value per share is simply the current price of a publicly-traded stock.
Components of book value per share
Investors use the book value per share to evaluate a company’s stock price. Following are the components of BVPS that one should consider:
Book Value of an asset = Original Cost – Accumulated Depreciation
Book Value of a company = Total Assets – Total Liabilities
Total Assets = Non-Current Assets + Current Assets
Total Liabilities = Non-Current Liabilities + Current Liabilities
Number of shares outstanding = Number of issued shares – number of shares held in the company’s treasury or Float shares available to the public, excluding restricted shares or shares held by insiders.
The average number of common shares
To calculate book value per share, the average number of common shares is considered over the total number of common shares because stock buybacks and other events can affect the book value per share and make a stock overvalued or undervalued.
Many times, stocks are found to be trading below their book value. Why?
There are two reasons:
- If investors do not have faith in the company’s future and believe that its performance will decay in coming times.
- If the company is embracing aggressive accounting policies in order to overinflate its net worth.
Calculation of book value per share
Book value per share formula is as follows:
BVPS = ((Total Shareholders’ Equity – Preferred equity) / Total outstanding common shares)
Where Total shareholders’ equity is calculated as:
Total assets- Total liabilities / No. of outstanding common shares
For example, Company A has Rs. 100 cr. of shareholder’s equity, including preferred stocks of Rs. 20 cr. Furthermore, the average number of shares outstanding is 10 cr.
Book value per share = (100,00,00,000 – 20,00,00,000) / 10,00,00,000
= 80,00,00,000 / 10,00,00,000
= Rs. 8
Thus, the book value per share of company A is Rs. 8.
How do companies increase the book value per share?
- A company can use its earnings by investing in its assets to increase its shareholders’ equity.
- It can reduce liabilities using its profits; resultant, its common equity and book value per share will increase.
- It can use its earnings to buy back shares.
Let us take the example mentioned above. If a company decides to repurchase two cr. common stocks from its shareholders, it can reduce its share outstanding to 8 cr. (10 cr. – 2 cr.)
The revised book value per share = (100,00,00,000 – 20,00,00,000) / 8,00,00,000
= 80,00,00,000 / 8,00,00,000
= Rs. 10
By buying back two cr. common stocks from its shareholders, the company can increase the book value per share from Rs. 8 to Rs. 10.
What does book value per share denote and its importance in analysis?
The book value of a share is an important analysing method used by investors to know if a company’s share price is undervalued. Following are the points that signify its importance:
- If investors find that the company’s book value per share has increased, its stocks become more valuable.
- Finding a negative book value per share shows the company’s liabilities exceed its assets. Such a situation reflects balance sheet insolvency, and the stock may not be a good investment option.
- The price-to-book value shows whether a share is undervalued or overvalued. On the other hand, book value per share gives you the value compared with its market value per share.
Should you worry about book value per share as an investor?
The answer is yes because the company can be punished/pushed unfairly by the market due to stated book value that may not represent the actual value of its assets. It may be a value trap rather than a value opportunity as companies’ assets can be treated differently in different industries.
It is important to know how fast a company’s assets get appreciated. The company’s past financial statements will help you find out the depreciated values.
An asset value at which it can be sold matters as it is used to pay shareholders at liquidation. It may be that a company has equipment that gets depreciated rapidly, but the book value is overstated. In contrast, a company may have an asset that does not depreciate rapidly, like oil and property, but it has been overlooked and has understated book value.
In a nutshell, it is important for investors to understand the various prices associated with a stock like book value, market value, and ratios like P/E ratio, P/B value, etc., to have a 360-degree overview always.
If a company’s book value per share exceeds its current stock price, the stock is considered undervalued. If the book value per share gets increased, the stock becomes more valuable. The stock price will also rise in the market if a company’s share price goes below its book value per share, giving rise to an opportunity for making risk-free profits. But if the stock holds negative book value, then it represents a company’s liabilities are more than its assets, resulting in balance sheet insolvency.
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