Let’s start with a few basic definitions.Book value of a stock is the shareholder’s equity of a business, measured in assets and liabilities, as determined and measured by the accounting books.Book value is a term that is used when you are differentiating between the current, immediate market price of a stock and the accounting measures that will usually measure the historical cost.In other words, the book value is a company’s common stock equity as it would appear on a balance sheet.It is the total assets minus the liabilities, the preferred stock, and any intangible assets.You can look at it as being how much money the company would have in assets if it went out of business right now.The book value is generally less than the market capitalization of a company because companies are expected to hopefully grow, become more profitable, and get more money in the future.If you are a value investor, then book value is important to you.If you are a growth investor, then book value won’t be as important to you.
Book value can refer to different things and be used in different ways.Here’s how:
- Book value can refer to the total equity of a company.
- Book value can be used as a per share value.In other words, the equity value on the balance sheet is divided by the number of outstanding shares at the date of the balance sheet.This is not the average outstanding shares in the period, but the actual number at that date.
- Book value can be used as diluted per share value.In other words, the balance sheet equity is heightened by the exercise price of the options, the warrants, or any preferred shares.Then the balance sheet equity is divided by the number of shares-the number that includes all of the added shares.
So why is the book value important for you to know?Book value is another way of determining the value of the company and whether or not it would be a good idea for you to invest in the company.The book value is an approximation of what you as a shareholder would get if the company liquidated right now.If the company is trading at a price that is below its book value, then this means that the company would be worth more if it did liquidate at this time.If a company is going well but is trading at a level below its book value, then it might be a good investment.If a company is about to go down and is trading below its book value, then paying the book value would be overpaying.
Book value is also used in the ratio price/book.This is a value that sets the floor for prices in the case of a worst-case scenario.If a company ends up being liquidated, then perhaps the book value is all that the owners, or shareholders, will end up getting.If you pay a price/book ratio of 1, then you will get all of your money back if the company liquidates. If you are investing in a capital intensive industry, then the companies will be trading at a lower price/book ratio.This is due to the fact that capital intensive industries get lower earnings for each dollar of assets.If an industry depends on human capital, then it will trade at a higher price/book ratio.A book value per share measurement can also be used to determine a value of comprehensive earnings.
The book value will change if the sale of shares per unit by the business increases.The book/share ratio will increase if the new shares are issued at a higher price than the preexisting ones.Also, if a company decides to buy its own shares, then the total book value will decrease.If dividends are paid, then the book value also decreases.