Stock market investment involves a deep knowledge of financial ratios used to determine the value of a company. One of the most important of these ratios is Book Value. In this blog, we will analyze book value, its importance, how to find it, and how it can be used in stock market analysis, with Hindustan Unilever Limited (HUL) taken as an example.
Book value refers to the amount shareholders would receive if a company’s assets were liquidated, and all liabilities were paid off. It essentially represents the net asset value of a company.
Book Value (BV)= Total Assets- Total Liabilities
Book value is a fundamental indicator of a company’s financial health, often used in conjunction with other valuation methods.
Prior to the calculation of book value, total assets and total liabilities need to be understood:
Total Assets:
All resources owned by the firm, classified as:
Short-term assets: Cash, accounts receivables, inventories.
Long-term assets: Machinery, real estate, patents, and investments.
Total Liabilities:
These are the debts a firm owes, classified as:
Short-term liabilities: Accounts payable, short-term loans, accrued expenses.
Long-term liabilities: Debt, bonds, deferred tax liabilities.
Book value is the difference between a company’s total aggregate assets and liabilities. Here, assets include all the fixed and current assets, and liabilities include current and non-current liabilities.
The formula to calculate book value is:
Book value: Total assets – Total liabilities
In some cases, financial analysts exclude the intangible assets while calculating the book value since the book value of intangible assets can not be determined during the company’s liquidation process. In such a case, the formula for book value changes to:
Book value: Total assets – (Intangible assets + Total liabilities)
Here is an example with the balance sheet of Company ‘A’ for calculating the book value:
Assets | Amount (In Rs.) |
Current assets |
|
Cash and cash equivalents | Rs. 50,000 |
Accounts receivable | Rs. 30,000 |
Inventory | Rs. 20,000 |
Total current assets | Rs. 1,00,000 |
Non-current assets |
|
Property, Plant, and Equipment | Rs. 2,00,000 |
Intangible assets (Goodwill, etc.) | Rs. 50,000 |
Total non-current assets | Rs. 2,50,000 |
Total assets | Rs. 3,50,000 |
Liabilities and equity |
|
Current liabilities |
|
Accounts payable | Rs. 40,000 |
Short-term debt | Rs. 20,000 |
Total current liabilities | Rs. 60,000 |
Non-current liabilities |
|
Long-term debt | Rs. 1,00,000 |
Total non-current liabilities | Rs. 1,00,000 |
Total liabilities | Rs. 1,60,000 |
Equity |
|
Common stock | Rs. 50,000 |
Retained earnings | Rs. 1,40,000 |
Total equity | Rs. 1,90,000 |
Total liabilities and equity | Rs. 3,50,000 |
Calculation of book value:
Book value: Total liabilities – Total assets
Book value: Rs. 1,60,000 – Rs. 3,50,000 = Rs. 1,90,000
Thus, the book value of company ‘A’ is Rs. 1,90,000
What are the measures of book value
Shortening a company’s total liabilities from its assets gives an approximate idea of the actual value of a company. For a deeper understanding, investors usually use various metrics to come as close to the real booking value of a company as they can. A method used here is arriving at the Book Value of Equity Per Share (BVPS).
Book value per share (BVPS):
Book value per share is a book value measure where the net worth of a listed company’s asset (shareholder equity) is used and divided by the number of outstanding shares. It is among the most employed measures by investors who wish to understand their amount of earnings should the company wind up.
For instance, the company ‘A’ has 10,000 outstanding shares and shareholder equity of Rs. 1,90,000. BVPS in this scenario will be as follows:
BVPS = Net worth of assets or shareholders’ equity / total number of outstanding shares.
BVPS = Rs. 1,90,000 / 10,000 = Rs. 19 per share
The book value per share of company A is Rs. 19 per share.
Although this appears to be promising, it is not the whole picture. To get a better idea of XYZ’s prospects, investors will have to use other ratios in conjunction with the BVPS. Another one of these is the price-to-book-value (P/B) ratio, commonly referred to as the price-to-equity ratio. .
Price-to-Book (P/B) value ratio is a financial measure that relates a company’s market value to its book value. Therefore, P/B ratio also comes from the book value of the company. It is applied to determine whether a stock is overvalued or undervalued by evaluating the market valuation of a company with its book value as per its balance sheet.
Formula: Market price per share/book value per share (BVPS)
Suppose company ‘A’ has BVPS of Rs. 19, and the market price per share is Rs. 38. Then P/B ratio would be determined as:
P/B ratio: Market price per share/book value per share (BVPS)
P/B ratio: Rs. 38/Rs. 19 = 2
Hence, P/B ratio for Company ‘A’ is 2.
Book value is crucial for investors to know if the share price of a firm’s stock is warranted. Therefore, value investors who are long-term investors make their investments on thoroughly studying a firm’s book value. These investors prefer companies with high book value since they are considered safe investments. This is due to the fact that firms with high book value have large tangible assets that can be sold if there is a need. In addition, investors consider book value figures like BVPS and P/B ratio for evaluation.
Investors utilize the P/B ratio in order to gauge the firm’s market value in relation to its book value and determine whether the stock is undervalued or overvalued. If the stock is overvalued, investors book profit and sell short. Conversely, in case the stock is undervalued, value investors buy it with a view to earning profits from its rise in price in the future. If a P/B ratio is 1, it means that the stock is undervalued, and if the P/B ratio is greater than 1, it means the stock can be overvalued.
Secondly, by employing BVPS, investors are able to determine whether a stock is overvalued, undervalued, or fairly valued in the market. For instance, if a firm’s BVPS is less than its market price per share, the stock will be overpriced unless there are high intangible assets or future growth possibilities, which are worthy of paying a higher price for. If, however, the BVPS approaches or surpasses the present market price, the stock can be undervalued, revealing an opportunity for purchase.
2) The Capital Market Division
The Capital Market Segment of the NSE allows traders to engage in the trading of securities such as debentures, equity shares, exchange-traded funds, preference shares, and retail government securities. – (What is NSE)
From a value investment perspective, book value is of immense significance. As an investment approach, value investing goes beyond what a company’s balance sheet is reflecting. Keeping in mind the stocks that are underpriced or undervalued, value investors utilize the book value of a company to gauge its real standing in the market.
If an investor can find companies that are doing significantly better than what their revenues indicate, and if such companies’ stocks are trading at a price lower than their book value, then such an investor is ready to earn enormous profits by purchasing those stocks. For example, if a firm’s P/B ratio is less than 1, it implies that its stock is undervalued, meaning that its book value is greater than its market cap. Conversely, if the ratio is greater than 1, it means that its market cap is greater than its book value and its stock is thus overvalued.
Book value allows investors to comprehend the discrepancy between what revenue data of a company is reporting and how the company is actually viewed by the market.
There are key differences between a company’s market value and its book value. The book value indicates the overall worth of a company based on its financial statements and performance. On the other hand, the market value shows how much the market believes the company is worth.
When the market value is higher than the book value of a company’s shares, it suggests that the market sees potential for growth that could create additional value. Conversely, if the market value falls below the book value, it signals that the market and investors may have less confidence in the company’s growth prospects, even if the book value is greater.
Therefore, it’s important to compare both the book value and the market value to determine if a company’s stock is a good investment.
Book value is a very useful tool for investors to estimate the position of a company in the market in an overall manner and make informed investment choices. For companies, publishing accurate financial information is most important if they want to grow, evolve, and attract long-term value investments. Investors, however, need to analyze the book value along with other information on a company before investing in it.
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Registered Office:
3-1-309/310, Tara Kaushalya Nivas,
Nimboliadda, Kachiguda, Hyderabad-500027
Contact: +916300169336
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Mumbai Office:
C/o.15B,5B, 1st Floor, Royal Industrial Estate,
Sewree Wadala Road No.26, Wadala(West),
Mumbai-400031
@2023 4R Investments. All right reserved.
Website by Vrinda Techapps
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