When it comes to determining the value of a company, two of the most effective measures to utilize are book value and market value. In general, book value is an objective assessment that represents the financial strength of a company based on its assets, while market value is a more subjective assessment based on the attractiveness of a company’s share value.
In this article, we’ll dive deeper into what the terms book value and market value mean, explain the key differences, explore the limitations of each, and discuss how to use them together to evaluate companies and stocks.
What is Market Value?
Also known as market capitalization, market value encompasses the value of a company on the stock market. You can also think of it as the amount it would take to purchase every share of a company’s stock at the current trading price.
Market Value = Current Market Price Per Share x Total Shares Outstanding
Example: If Company A has a stock price of $100 per share and has 50 million shares outstanding, the market value would be $5 billion. $5B = $100 x 50 million.
Because the market value depends on the stock market, it can be more volatile and shift throughout the day. However, unless there are drastic changes in the company, industry, or broader equity market, and unless the company enacts stock buybacks or issues more shares, the number won’t change too drastically on a day-to-day basis.
What is Book Value?
Book value takes into consideration hard financial figures: assets and liabilities. It can largely be seen as the amount the company would be worth if it were liquidated.
To calculate book value, you look at the balance sheet and take assets (physical things like equipment, real estate, etc.) minus intangibles (intellectual property, patents, etc.) and liabilities (loans, taxes, debt, etc.)
Book Value = Total Assets – Intangible Assets – Liabilities
Example: If Company A had total assets of $50 million, $5 million of which were intangible assets, and liabilities of $10 million, the book value would be $35 million. $35 million = $50 million – $5 million – $10 million.
What are the Key Differences in Book Value vs Market Value?
The main differences are the basis of the values, fluctuation, accessibility, timeliness, and accuracy.
- Basis of value: Market value depends on share price, while book value looks at hard financial figures like assets and liabilities.
- Fluctuation: Market value fluctuates based on investor perceptions and involves intangibles like future growth prospects. Book value doesn’t vary as much.
- Accessibility: Market value is relatively easy to find by looking at online stock listings and corporate profiles. Book value, in contrast, requires an understanding of a company’s accounting practices and tax law and can be an adjustable figure.
- Timeliness: Market value updates daily, while book value is updated only quarterly or annually when companies report their financial statements.
- Accuracy: Market value is based on perception and may not be an accurate representation of value, while (accurately reported) book value is a pretty good indicator of financial health.
What are the Limitations of Book Value and Market Value?
Book value may be subject to adjustments such as depreciation, which is not always easy to understand and assess. It also does not always include the full impact of bankruptcy or claims on assets such as liens. It can also be difficult to assign value to intangibles like intellectual property, which raises questions on book value.
Market value represents the perception of the company’s valuation, which doesn’t always reflect the whole picture. Stocks can be overbought or oversold according to technical analysis, and also be subject to economic volatility like manias or panics.
Using Market Value and Book Value Together
When it comes to investing, book value and market value are best together in tandem. One is not superior to the other when it comes to valuation – the real advantage comes in comparison. When set against each other, they help investors to determine if stocks are overpriced or underpriced.
Calculating the Value of Stocks Using Market Value and Book Value
The general rule is this: if book value is higher than market value, it suggests an undervalued stock. This can be a good time to buy, as the stock price will likely rise as the market realizes the intrinsic strength of the company.
Conversely, if book value is lower than market value, it indicates that the stock is overvalued. The financials do not back up to the perceived worth.
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We hope this article answered some of your questions about market value and book value when it comes to valuation. For answers to more valuation questions, contact us at info@visionpointcapital.com.
