Many investors and business owners use a company’s book value as one of their key considerations when deciding whether or not to purchase shares. Therefore, it’s essential for anyone considering investing in a company or buying shares from an existing investor to understand what the book value represents.
The most basic definition of book value is the total amount of money returned to shareholders if the company were to dissolve and sell its assets.
In other words, it’s how much you could get back if you sold all your company’s assets.
What Is Book Value?
Book value is the total amount of money returned to shareholders if the company dissolved and sold its assets. The book value per share is calculated by dividing the book value by the number of shares outstanding.
The book value is sometimes recorded on the balance sheet under “stockholders equity.” This reported number provides information to investors about how much they would recover if they liquidated all of their assets.
In addition, it tells investors how many dollars per share are available if it decides to sell off its business and pay back its shareholders.
Understanding Book Value
When a company dissolves, its assets are sold to shareholders to return value. The total amount of money that would be returned to shareholders is known as the company’s book value. This figure gives investors an idea of how much each share is worth.
The cool thing is that the book value of a company’s equity generally doesn’t change: if you know how much money your company is worth right now (the “book value”), it will be worth the same amount tomorrow as well.
When a company’s stock price increases significantly, it can sometimes lead to a “market capitalization rate.” When this happens, market capitalization-weighted stock portfolios are likely to include the company.
The phrase “market capitalization” is used when calculating the market value of a company’s shares, assets, or liabilities.
Market capitalization is calculated by multiplying the current market price per share with the number of outstanding shares in a publicly-traded company. This figure gives investors an idea of how much each share is worth.
How to Calculate Book Value: Book Value Formula
A company’s book value is the total value of its assets, including cash and investments. To calculate the book value per share, divide the total book value by the number of shares outstanding, giving you the company’s net worth per share.
For example, if a company has $100 million in assets and 10 million shares outstanding, its book value per share is $10.
Book Value Per Share (BVPS)
Book value per share is a calculation used to determine the worth of a company’s assets. This calculation is derived by dividing a company’s total book value by the number of shares outstanding.
The BVPS gives investors an idea of how much they would receive if the company were to dissolve. If the book value per share is equal to the current share price, then it can be said that investors are not paying above what a company is currently considered worth.
When calculating book value per share, first find the net assets. To do this, subtract total liabilities from total assets. Next, divide net assets by the number of outstanding shares.
In the case of a company with $50,000 in assets and $40,000 in liabilities, net assets would equal $10,000. When divided by 10,000 total shares of stock outstanding, this gives us a book value per share of $1.00 ($10,000/10,000).
The formula for book value per share is:
Total Assets – Total Liabilities/Number of Shares Outstanding
The book value per share ratio is calculated by taking the market capitalization and dividing it by the total amount of shareholder equity, which can be found on a company’s balance sheet. If the result of this calculation yields a ratio that is more than one, then the stock is undervalued.
This means that market capitalization is currently higher than the value of total shareholder equity, which suggests that the share price should be higher to bring it closer or at parity with its book value per share.
On the other hand, if the result yields a ratio of less than one, the stock is overvalued, which means it will take more money to buy a share of stock than its book value per share.
The book value per share ratio formula is market capitalization/shareholder equity.
The following are examples of how to calculate book value per share and book value per share ratios:
Example 1:
Company A has 10 million shares outstanding and a book value of $1,000,000. How much is each share worth?
Net assets / Total Shares Outstanding = Book Value Per Share
$1,000,000/10,000 = $100 per share. This stock will trade around $100/share.
Example 2:
Company B has 50 million shares outstanding and a book value of $10,000,000. How much is each share worth?
Net assets / Total Shares Outstanding = Book Value Per Share
$10,000,000/50,000 = $200 per share. This stock will trade around $200/share.
Example 3:
Company C has 100 million shares outstanding and a book value of $30,000,000. How much is each share worth?
Net assets / Total Shares Outstanding = Book Value Per Share
$30,000,000/100,000 = $300 per share. This stock will trade around $300/share.
In the examples above, it must be noted that book value per share and Book value per share ratios are only valuable for determining if a company is undervalued or overvalued compared to similar companies in its industry.
In all three cases, the company with the lowest number of shares outstanding is the one that appears to be undervalued. In contrast, the company with the highest number of shares outstanding is overvalued.
However, this comparison does not consider any other factors, such as management’s strategy for future growth or an upcoming cash infusion via a merger or acquisition, that could alter a stock valuation.
How to Increase the Book Value Per Share
- Find out what is currently affecting the company’s business that can be fixed or changed
- Take advantage of any opportunities in the market by acquiring competitors and merging with them
- Increase the number of shares issued
- Invest in projects with high economic returns
- Focus on increasing productivity of both fixed and current assets
- Reduce finance costs over time by issuing bonds with lower interest rates
- Pay down debt if it is high or replace it with cheaper debt
- Reduce expenses by closing underused facilities, reducing pension benefits, and renegotiating supplier contracts
- Take all the above actions together in a way that is sustainable over time so as not to increase the risk of bankruptcy or shareholder lawsuits
- Dispose of non-core assets such as real estate or sell off divisions that are not making money for the company
- Sell off non-core assets such as real estate
- Ask shareholders to buy back shares and retire them, thereby reducing the number of shares outstanding and increasing per-share book value
The company can do everything in steps 3, 5, 6, 8, 9, and 12.
Steps 3, 5, 6, and 8 are critical to increasing book value per share. However, they must be done sustainably to reduce business risk.
If the company does nothing about it currently, selling non-core assets will worsen since no one wants to buy them and isn’t generating any revenue.
Book Value vs. Market Value: What’s the Difference?
Book value is one way to measure a company’s net worth, while market value is the perceived worth of a company as determined by the stock market.
The two measures can be different for various reasons, including differences in earnings, assets, and liabilities. For example, book value and market value can differ because earnings can affect the two measures differently.
Book value is based on a company’s total assets and liabilities, while market value is based on the stock price multiplied by the number of outstanding shares. This means that if a company has high earnings, its book value will be higher than its market value, and vice versa.
Another reason book value and market value can differ is because of differences in the types of assets held by a company.
For example, book value measures the liquidation value of a company’s assets, while market value can be impacted by changes in non-cash assets or long-term investments.
Limitations of Book Value
A company’s book value measures its net worth, but it has limitations.
First, book value only reflects the value of a company’s assets and liabilities at a specific point in time. This means that it does not consider any future earnings or changes in the market value of a company’s assets.
Second, book value does not reflect the difference between a company’s market value and its liquidation value. This means that a company could be worth more or less than its book value, depending on how easily its assets could be sold.
Finally, book value does not consider the intangible assets (such as goodwill) or liabilities (such as pensions) of a company.
Conclusion
A company’s book value is the total amount of money that would be returned to shareholders if it were to dissolve and sell its assets.
Suppose you are looking for ways to increase your company’s net worth, there are many things you can do, including taking advantage of any opportunities in the market through acquisitions or mergers, increasing productivity with current assets, reducing expenses over time through cost-cutting measures such as closing underused facilities or renegotiating supplier contracts, etcetera.
You should also take all these actions together so they are sustainable over time without risking your business.
However, while there are many ways to increase book value over time, the company mustn’t focus on its core business.
Losing focus on growing revenue and customer satisfaction through new products means the company’s returns will eventually decrease even though you are taking action to increase your net worth.
Book value can be different from market value for various reasons, including differences in earnings, assets, and liabilities.
To better understand a company’s net worth, many investors analyze its market value. This analysis is more valuable since it considers changes in company assets and liabilities as well as earnings and any other indicia of a company’s value.
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