Understanding Book Value When Evaluating Stocks
A growing business should be worth more than its book value
How can you determine how much a company is worth and whether that value is reflected in the price of its stock? There are several ways to define a company's worth or value, and one of the ways you define value is referred to as market cap. How much money would you need to buy every single share of stock at its current price?
Another way to determine a company's value is to go to its balance statement and look at the book value.
What Is Book Value?
The book value of a company is simply its assets minus its liabilities. This means the total value of its assets not including intangible assets with no immediate cash value, such as goodwill. Liabilities include monies owed and operating expenses. So Book Value = Assets - Liabilities.
In other words, if you wanted to close the doors of the business, how much money would be left after you settled all the outstanding obligations and sold off all the assets? That's the company's book value. A company that is a viable growing business will always be worth more than its book value because of its ability to generate earnings and growth.
Using Book Value in Investing
Book value appeals more to value investors who look at the relationship to the stock's price by using the price to book ratio. If you want to compare companies, you can convert to book value per share, which is simply the book value divided by the number of outstanding shares.
Other Components of Investing
A company's book value and its book value per share are just two small components of an overall investment calculation and strategy. You won't want to jump in with both feet until you understand all of these components. Here are a few other common terms you might want to look into and make sure you understand.
- Earnings per share (EPS): The percentage of a company's profit that is dedicated to each share of stock.
- Price to earnings ratio (P/E): This measures the current price of a share against per-share earnings.
- Projected earnings growth (PEG): A method of evaluating the price to earnings ratio in comparison to the growth ratio.
- Price to sales ratio (P/S): A company's market cap divided by its most recent yearly revenue. P/S can also be determined by dividing the price of a stock per share by per-share revenue.
- Price to book ratio (P/B): This compares a stock's book value to its market value.
- Dividend payout ratio: The number of dividends paid to stockholders versus the company's total net income.
- Dividend yield: This is a percentage of the current price of a share.
- Return on equity (ROE): A company's profitability in relation to the book value of each shareholder's equity.
NOTE: Please consult with a financial advisor for the most up-to-date advice and answers to any specific questions you might have. The information contained in this article is not intended as investment advice and it is not a substitute for investment advice.