Before investing in an asset, every investor ensures the value and the future potential of that asset. One such investment avenue is the equity which is one of the most popular asset class for investors. Investing in equity means that you have purchased partial ownership of a company. Before investing in a particular company, the investor has to be aware of the financial stability, future growth and potential of the company. Some basic research followed by a lot of discipline is required to extract good returns from the equity market. You would certainly like to invest in a good company and there are many parameters to assess the value of a share. ‘Book Value’ is one such parameter which tells us about the value of a share. We will learn more about book value in the post.
What is Book Value of a Company?
Book value is the value of total assets or the net equity of a company. In case of public companies, it is also known as total shareholder’s equity. Book value includes the value of all the assets, property and equipment owned by the company. It also incorporates cash holdings and inventory on hand. To get the book value of the company, you must subtract all the liabilities such as debt or tax liabilities from the value of total assets of the company. You can find these values in the balance sheet of the company.
What is Book Value Per Share?
Book value per share (BVPS) helps the investor to determine whether the market value of a particular stock is underpriced or overpriced. Book value per share is calculated by dividing total equity available to common shareholders with the total number of shares outstanding. The book value per share is compared with the market value of the share to make insight into how a company’s stock is valued.
If the BVPS is higher than the market value of the stock, then the company’s stock may be undervalued and if it is less than the market value of the share then the company’s stock may be overvalued.
Book value per share (BVPS) is generally an indicator of the absolute value of share as compared to its current market price. By looking at the book value, you can determine if a particular shear is undervalued or not.
How the Book Value per Share (BVPS) is Calculated?
To calculate the book value per share, you must first determine book value (equity) of the company and then divide it by the number of common shares. Since you are considering common shares, you must subtract the preferred shareholder equity from the total equity. Otherwise the book value would be inflated or inaccurate.
Example: Suppose a company has USD 35 million worth shareholder’s equity, USD 10 million worth of preferred equity and 5 million total outstanding shares.
Book Value Per Share = ($35 million -$10 million)/5 million = $5
Significance of BVPS
Book value per share is mainly used by the investors to determine if the share price is undervalued. This is done by comparing the book value per share to the market value of the share.
| BVPS of the share > its current market price | The share is undervalued. |
| BVPS of the share increases | The share will be more valuable and the market price of the share will increase. |
| If the BVPS is negative | Total liabilities of the company are more than its assets and the financial position of the company is not sound. |
- If the BVPS of the share is more than its current market price, then the share is undervalued.
- If the BVPS of the share increases, it means the share will be more valuable and the market price of the share will increase.
- If the BVPS is negative, it means that the total liabilities of the company are more than its assets and can be interpreted as the financial position of the company is not sound.
While this is a good parameter to assess whether the stock is undervalued or not, it is not the sole determining factor for the investment decision and it should be seen in combination with other factors like the past earnings of the company, etc.
What is P/B and what is its Significance?
When the current price of the share is divided by the book value per share, we get a parameter called P/B (price to book value ratio). P/B is also a tool which helps an investor for making investments decisions regarding a particular stock. It can be interpreted in the following ways:
| P/B < 1.0 | the stock is undervalued |
| P/B > 1.0 | the share is overvalued |
| P/B = 1.0 | the stock value of the company is at par |
(a) P/B Ratio is less than 1.0
It indicates that the stock is undervalued and it is an opportunity for the investors looking to add undervalued stocks in their portfolio. It can be interpreted that if the company goes bankrupt, the shareholder can still make profit even after the company settles all its liabilities.
(b) P/B Ratio is more than 1.0
It means that the share value of the company is bloated and in case the company is liquidated the investors may lose their money.
(c) P/B Ratio equal to 1.0
It indicates that the stock value is at par and can be interpreted that the investor will neither make or lose money it the company is liquidated and shareholder’s wealth will remain unchanged.
Conclusion
Book value per share is an important parameter for investment decision regarding a particular stock. However, it should not be read in isolation but should be read in combination with other factors. Buying decision for a stock should not only be based on the fact that its price is below its book value. The investor should also carefully research other aspects of the company before making any investment decision.
Also read: How Stock Split is Different from Stock Dividend?
