Learn the Definition and Importance of the Book Value Per Share
Avoid Confusing It With Market Value
Book value represents a company's assets minus its liabilities and sometimes is referred to as stockholders' equity, owners' equity, shareholders' equity, or simply equity. The book value per share formula is used to calculate the per share value of a company based on its equity available to common shareholders.
Book value per share is a market value financial ratio, and the purpose of calculating it is to relate shareholders' equity to the number of shares of common stock outstanding. The number of shares of preferred stock is not considered, making book value more directly relevant to common shares outstanding.
Finding the Value
Here is the calculation of the book value per share:
Book value per share = Shareholders' equity ÷ Average number of common shares
It's important to use the average number of outstanding shares in this calculation. A short-term event, such as a stock buy-back, can skew period-ending values, and this would influence results and diminish their reliability.
Interpreting the Value
This measurement is used by investors to evaluate the price of a company's common stock. For instance, if the market value per share is lower than the book value per share, then the stock price may be undervalued.
However, book value is not market value. The book value of owners’ equity is not directly tied to the market value of a business and is essentially an accounting value, subject to management discretion in accounting policies. Book value may be considered in varying degrees in putting a market value on a business and its ownership shares.
There are interesting ways to look at book value. If market value is much higher than book value, the financial markets are likely experiencing a bull market. If the values are closer together, the financial markets may be in a bear market.
Tangible vs. Intangible Assets
Some companies will have a lot of assets in the form of real estate or equipment, while other companies might have less tangible assets such as copyrights and trademarks. Even an experienced sales staff can be considered an asset because of the revenue it can generate. Even if the book value per share is similar for two different companies with different types of assets, the market value might be significantly different depending on how that industry values those specific types of assets at a given time.
A Practical Example
Fictional Company A has $20 million worth of stockholders' equity, $5 million worth of preferred stock, and an average of 5 million shares outstanding. The calculation of its book value per share is:
($20 million [Stockholders' equity] – $5 million [Preferred stock]) ÷ 5 million [Average number of common shares] = a book value per share of $3.
There are two issues to consider:
- The market value per share is a forward-looking measure of what a company's shares are worth; conversely, the book value per share is an accounting measure that is not forward-looking. The two measures are completely different and are based on different information.
- Some assets tend to be undervalued in the book value concept, sometimes considerably, because it is not easy to put a cash value on them. Brand and reputation, for example, may take years to nurture. In-house proprietary research and development can be extremely valuable, but in this calculation may be seen only as an expense. Patents, goodwill, and intellectual property also fall into this category. These factors can contribute to the disparity between book value and market value.