Book value is the theoretical amount of money that would remain for shareholders if a company liquidated all of its assets and paid off all of its liabilities.
Understanding book value
The calculation for book value relies entirely on a company’s balance sheet. Analysts determine this metric by taking the total assets of a business and subtracting its total liabilities. Assets include cash, real estate, equipment, and inventory. Liabilities consist of debt, accounts payable, and other financial obligations. The resulting figure represents the net asset value of the company.
Elephants analyzing stocks will notice that a company’s book value rarely matches its market value. Market value is the price investors are willing to pay for the company on a public stock exchange. Stock prices reflect investor expectations about future earnings and growth. Book value is an accounting metric that looks only at the historical cost of assets minus accumulated depreciation. Many modern technology companies trade at high multiples of their book value because their primary assets are software and intellectual property, which do not translate directly to traditional balance sheet metrics.
Investors frequently use the price-to-book ratio, or P/B ratio, to evaluate whether a stock is overvalued or undervalued. To find this ratio, an investor divides the current stock price by the book value per share. A ratio below 1 indicates that the stock is trading for less than the value of the company’s net assets. Value investors often screen for low P/B ratios to find potential investments.
Accounting standards dictate exactly how a company records its assets and liabilities, which directly affects the book value. International Financial Reporting Standards and various local accounting rules require companies to depreciate physical assets over time. If a company owns a fleet of delivery trucks, the recorded value of those trucks drops every year on the balance sheet. This depreciation lowers the total assets and reduces the book value, even if the actual liquidation value of the physical trucks is higher or lower in the open market.
Example
Consider a fictional eco-tourism company called Savannah Safari Group that operates large nature reserves and employs herds of working elephants for guided tours. The company lists $50 million in total assets on its balance sheet. These assets include land, guest lodges, transport vehicles, specialized veterinary equipment, and cash reserves. The company also has $20 million in total liabilities, consisting of outstanding bank loans and vendor payables.
To find the book value, an analyst subtracts the $20 million in liabilities from the $50 million in assets, resulting in a book value of $30 million. If Savannah Safari Group decides to close its operations, sell off the land, shut down the lodges, rehome the working elephants to a sanctuary, and pay back the bank loans, the remaining $30 million is the theoretical cash left for the shareholders.
If the company has 10 million shares outstanding, the book value per share is $3. If the shares are currently trading on the stock exchange for $2, the market is pricing the company below its book value. An investor might interpret this to mean the stock is cheap relative to its underlying assets.