Assessing Book Value
Also known as "cost value," book value measures what a company is worth to its stockholders, by calculating the difference between assets and liabilities.
Book value in relation to market value is a useful indication of investor confidence. If a company's market value is higher than its book value, it suggests that investors hold it in high regard (although in some sectors like high-tech or knowledge-based industries the difference is typically quite large, because they have fewer tangible assets). But where market value is dramatically higher, it may be that investors are over-confident—as in the recent dot.com boom and bust. Likewise a higher book value could suggest that investors are uncertain about the future—but it might also mean that stock is a particularly good buy at the moment.
A related measure, book value per share, is a way of assessing the true value of a company's stock. It shows how much each share would be worth in the event of company liquidation.
Book value is a simple calculation using figures taken from the company's balance sheet. Start with total assets, and then subtract current liabilities, long-term liabilities (such as debt), and preferred stock—as in the following example:
| $ | |
| Total assets | 2.5m |
| Current liabilities | -800,000 |
| Long-term liabilities, preferred stock | -500,000 |
| Book value | = 1.2m |
To work out book value per share, divide book value by the number of shares in circulation. So if the company in this example issued 60,000 shares, then the book value per share would be $1.2 million divided by 60,000:
- Variations on this formula include adjusted book value or modified book value (book value with assets and liabilities adjusted to their fair market values) and tangible book value (where intangible assets, patents, trademarks, and the value of research and development are also subtracted—the logic being that these can't be sold, unlike other assets).
- "Book value" can also be applied to individual assets by calculating the cost of depreciation and subtracting this from the value of the asset.
- Book value is generally regarded as a reliable measure, but it can still include inaccuracies. For example, fixed assets such as machinery or technological equipment may have plenty of value left in them for the company concerned, but if they've been superseded by more up-to-date models, their market value will be very low.
investopedia.com: www.investopedia.com/dictionary