Book Value vs. Market Value: An Overview
Although investors have many metrics for determiningthe valuation of a company's stock, two of the most commonly used are book value and market value. Both valuations can be helpful in calculatingwhether a stockis fairly valued, overvalued, or undervalued. In this article, we'll delve into the differences between the two and how they are used by investors and analysts.
Key Takeaways
- A company's book value is the amount of money shareholders would receive if assets were liquidated and liabilities paid off.
- Themarket valueis the value of acompany according to the markets based on the current stock price and the number of outstanding shares.
- When the market value is less than book value, the market doesn't believe the company is worth the value on its books.
- A higher market value than book value means the market is assigninga high value to the company due to expected earnings increases.
- When using book value and market value to evaluate companies against each other, it's important to compare companies within the same industry.
Book Value
The book value of a stock is theoreticallythe amount of money that would be paid to shareholders if the company was liquidated and paid off all of its liabilities.As a result, the book valueequalsthe difference between a company's total assets andtotal liabilities.
Book value is also recorded as shareholders' equity. In other words, the book value is literally the value of the company according to its books (balance sheet) once all liabilities are subtracted from assets.
The need for book value also arises when it comes to generally accepted accounting principles (GAAP). According to these rules, hard assets (like buildings and equipment) listed on a company's balance sheet can only be stated according to book value. This sometimes creates problems for companies with assets that have greatly appreciated; these assets cannot be re-priced and added to the overall value of the company.
Calculating Book Value
Below is the balance sheet for the fiscal year ending for 2021 for Bank of America according to the bank's annual report.
- Assets totaled $3.17trillion.
- Liabilitiestotaled $2.90trillion.
- The book value was $270 billion as of the end of 2021.
In theory, if Bank of America liquidated all of its assets and paid down itsliabilities, the bank wouldhave roughly$270 billion left over to pay shareholders.
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Market Value
Themarket valueis the value of acompany according to the financial markets. The market value of a company is calculated by multiplying the current stock price bythe number of outstanding shares that aretrading in the market. Market valueis also known asmarket capitalization.
For example, as of March 8, 2022, Bank of America hadover 8.07 billion shares outstanding while the stock traded at $38.65, making Bank of America's market value or market capitalization $312 billion (8.07 billion * 38.65). As of Dec. 31, 2021, Bank of America's market value was $359 billion.
Special Considerations
When the marketvalue of acompany isless than itsbook value,it may mean that investors havelost confidence in the company.In otherwords, the market maynotbelieve the company is worth the value on its books orthat there areenough future earnings.Value investorsmight look for a company where the market value is less than itsbook value hoping that the market is wrong in its valuation.
For example, during the Great Recession, Bank of America's market value was below its book value. Now that the bank and the economy have recovered, the company's market value is no longer tradingat a discount to its book value.
Book value and market value are just two metrics to evaluate a company, others include the debt-to-equity (D/E) ratio, earnings per share (EPS), price-to-earnings (P/E) ratio, and the working capital ratio.
When the market value is greater than the book value,the stock market is assigninga higher value to the company due to theearnings powerof the company's assets. Consistently profitable companies typicallyhave market values greater than their book values because investors have confidence in the companies' abilities to generate revenue growth and earnings growth.
When book value equals market value, the market sees no compelling reason to believe the company's assets are better or worse than what is statedon the balance sheet.
Book value and market value are two fundamentally different calculations that tell a story about acompany's overall financial strength.Comparing the book value to the market value of a company can also helpinvestors determinewhether a stock is overvalued or undervalued given its assets,liabilities, and its ability to generate income.
With any financial metric, it's important to recognize the limitations of book value andmarket value and use a combination offinancial metrics whenanalyzing a company.
Is Book Value the Same as Fair Value?
The book value of an asset refers to its cost minus depreciation over time. It is the value of an asset based on its balance sheet. The fair value of an asset reflects its market price; the price agreed upon between a buyer and seller.
Is Book Value a Good Indicator of a Company's Value?
Yes, book value can be a good indicator of a company's value.
If the book value per share is higher than its market value per share then it can indicate an undervalued stock. If the book value per share is lower than its market value per share, it can indicate an overpriced, or overvalued stock.
What Does a Negative Book Value Mean?
A negative book value means that a company's liabilities are greater than its assets. This indicates a company is possibly insolvent. This, however, does not mean that a company is a bad investment. One would need to dig further to understand why the book value is negative.
Correction—Feb, 1, 2023: This article has been edited from a previous version that incorrectly stated what a low book value indicates in terms of a company’s stock value. In reality, a low book value is an indicator that a company’s stock is overvalued, not undervalued.
