If you’ve been wondering what book value per share (BVPS) is, this post will explain what it is, how to calculate BVPS, and even how to increase it.

What is Book Value Per Share (BVPS)?

BVPS refers to the equity ratio obtained by subtracting all debt, liabilities, and the preferred stock liquidation price from the sum of an organization’s assets, followed by dividing the result by the common stock’s outstanding shares.

The resulting ratio is then termed as the representation of the minimum equity value of the company. The ratio is important because it helps determine a company’s book value based on individual shareholding.

Understanding BVPS

BVPS is important in a company setting because investors use the ratio to understand the value of their stock price. The ratio makes it easy to know whether or not the stock price is correctly valued.

The stock is undervalued where the current price is lower than the market value per share. Conversely, if the BVPS increases, the stock is considered to have a higher value, resulting in a price increase.

Theoretically, BVPS refers to the total value the shareholders should take home in a liquidation resulting in the subsequent sale of all the assets and payment of every liability.

But in such instances, the assets are often sold at the prevailing market rate while the book value uses the assets’ historical price. That explains why market value tends to come out as the preferred price compared to the firm’s book value.

Where the BVPS is higher than a company’s share price, a corporate raider helps to buy the company, sell its assets, and then liquidate it, resulting in a risk-free profit.

Where the book value is negative, it results in a scenario known as balance sheet insolvency, implying that the firm’s liabilities are more than the assets.

How to Calculate BVPS

The following is a formula for calculating BVPS, followed by a practical example of how to do the calculation.

BVPS = Stockholders’ Equity – Preferred Stock/Average Shares Outstanding

The “average shares outstanding” is the best option instead of the closing period amount since the latter may lead to skewed results where a significant issuance of stock happened or there was a large stock buyout.

“The closing period amount” often captures the short-term events and may consequently lead to the provision of incorrect figures. That unfortunate error may mislead investors and other stakeholders into thinking that the stock price is either undervalued or overvalued, while in reality, that’s not accurate.

Consider the Example Below

ACB Limited is a stockholder’s equity of $30 million.

$10 million is designated for the preferred stocks. And, they’ve got outstanding shares of $5 million.

That information is used to calculate ACB’s BVPS as follows:

BVPS = Stockholders’ Equity – Preferred Stock/Average Shares Outstanding

BVPS = $30,000,000 – $10,000,000/5,000,000

BVPS = $20,000,000/5,000,000

BVPS = $4

The firm can increase its BVPS by two main approaches. The first is to put measures that seek to reduce liabilities to the lowest possible levels or increase the value of their assets. Any of the two actions would result in ACB Limited generating more profits.

Assuming that the firm generates revenue of $700,000 and reinvests $300,000 towards acquiring more assets, the BVPS would increase besides the firm’s equity ratio. Similarly, the equity ratio would increase if the company used the amount to reduce its liabilities.

Besides the assets and liabilities approaches, there’s another way of increasing BVPS. ACB Limited can also opt to buy back common stock from the shareholders. Going back to the calculation, if the company bought back 1,000,000 shares and the rest remained outstanding, there would be a corresponding increase in BVPS.

Market Value Per Share vs. BVPS

A firm’s market value per share refers to the current stock price. The stock price captures the price that the participants in the market are willing and ready to pay to get the common shares. Although BVPS is calculated using historical costs, the market value per share is a futuristic tool that considers the firm’s future earning power.

Where there’s an increase in the firm’s profitability, it follows that there would be a corresponding growth in the firm’s overall value, thus increasing the stability of the business. However, the discrepancies between the market value per share and BVPS are common due to the different transactions’ classifications.

Companies use different techniques and strategies to build and reinforce their marketing campaigns. However, the US GAAP principles dictate that firms undertake immediate expensing of the marketing costs, which will reduce the BVPS.

On the other hand, firms may decide to charge premium rates if they determine that advertising can result in an enhanced brand image. Consequently, increased market demand will increase stock price resulting in a large difference between the BVPS and the market value per share.

How Firms Increase BVPS?

The following are the main ways through which companies can increase their BVPS.

1. Repurchase Common Stocks

The buying back of common stock from the firm’s shareholders is the third method that has proved effective in bettering BVPS.

From the earlier example, if the company repurchases a total of 1,000,000 common stocks, it would reduce the shares outstanding to 4,000,000 (5,000,000-1,000,000 = 4,000,000).

Consequently, the BVPS would be affected as follows:

BVPS = $30,000,000 – $10,000,000/4,000,000

BVPS = $20,000,000 – 4,000,000

BVPS = $5

As demonstrated, buying back common stock will increase BVPS from $4 to $5.

2. Reduction of Liabilities and Increase of Assets

One way is to reinvest part of a company’s profits to buy assets that directly increase the common equity.

As noted earlier, the company could also decide to use a percentage of the profit to reduce its liabilities, thus leading to increased BVPS and equity.

For instance, assuming ACB Limited generates sales worth $2.5 million and reinvests $500,000 to reduce liabilities and pay its debtors, there will be a corresponding increase in the common stockholders’ equity.

Disadvantages of BVPS

The major shortcoming with BVPS as a valuation method is that it doesn’t include other essential factors known to affect the firm’s value. It contains only the book value assets minus the intangible ones.

The justification here is that the common stockholders can only own the tangible assets in the firm’s liquidation. Intangible assets here include copyrights and trademarks. Due to this omission, there are possibilities of undervaluing the company since the intangible assets have a neglected value.