Book Value
| Other names for book value are owners equity, business equity, net assets, and net worth. |
Book value has slightly different meanings for different subjects. For the company overall, it is one of the simplest and one of the most important measurements of a company’s financial condition. Book value equals owners equity, or the company’s assets minus its liabilities as listed on the balance sheet.
Calculating the Net Book Value of a Company
| Assets – Liabilities = Owners Equity (Book Value) |
For property plant and equipment, book value equals the acquisition cost of the asset less the accumulated depreciation or amortization measured to date for the asset.
Calculating the Net Book Value of PP&E
| Original Cost – Accumulated Depreciation = Book Value, or Net Book Value |
Book Value and Financial Statement Analysis
Posted earnings, however, do not always equate to an increase in the company’s book value (see table below). Investors and management place much attention on short-term earnings estimates, quarterly and annual earnings reports, and stock prices. Eagerly awaiting the next quarterly report, investors often buy and sell on short – term information.
This expectation of short-term earnings places pressure on management to meet or beat those expectations, often sacrificing more important performance measures of long-term growth by focusing on short – term profits.
Ultimately, however, it is the growing value of the company and its book value that determines the successes and failures of management and the real return on investment.
In publicly traded companies, book value is measured as:
| Shareholders Equity/Shares of Stock Outstanding |
It is what the company is worth if it was liquidated today. For publicly traded companies, it is compared to the company’s market capitalization, or market value of all the company’s stock outstanding.
When the share price of a company’s stock is low in comparison to the book value per share, the stock is considered a bargain. Conversely, if the share price is high in relation to the company book value, the stock is considered expensive and possibly overpriced. Investors are either expecting an increase in future earnings, or are paying too much for the stock.
Book Value vs. Fair Market Value
Book value is based on what the company paid for assets at the time of purchase, less any accumulated depreciation, as listed on the balance sheet. However, the fair market value of an asset, or what an asset is currently worth on the market if it was sold, may have no relation to what the value is on the balance sheet. For example, the company may have received a substantial discount on the asset. The asset could be worth much more than what the company paid for it, which is common for land purchased many years ago, or the asset may be obsolete and worth much less than the value listed on the balance sheet.
| The book value measures the original cost of an asset on the balance sheet less depreciation, not the actual fair market value of the asset. |
Nonetheless the value of a company as listed on the balance sheet reveals the long-term growth or loss in owners equity, and the intrinsic value of a company, much better than short-term performance measures. For publicly traded companies, an increase in owners equity is directly related to an increase in stock price.
In the 1924 Classic Common Stocks as Long-Term Investments, Edgar Lawrence Smith wrote that the best way to increase the value of a stock or investment is to increase the value of a firm. The best way to do this, according to Smith, is for management to continually increase retained earnings. An increase in business equity through retained earnings will escalate the stock price.
This is a long-term correlation. In the short-term, stocks are subject to fickle buyers and sellers that give way to buying frenzies and selling panics. In the long-term, however, there exists a strong correlation between stock value and the value of a company.
Why Short Term Profits Do Not Necessarily Increase a Company’s Book Value:
Accountants can manipulate short-term earnings in a variety of ways to paint a picture of consistent and growing earnings. Over the long-term, however, growth in owners equity tells the true story of how a company has performed over the years.
The below table shows three common examples of how earnings are manipulated:
Short-Term Earnings and Accounting Gimmicks
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In the long run, though losses are sometimes manipulated in one form or another, the effect of these losses on assets and business equity is very real, and is reflected in the book value and eventually the stock values of the company.
The long-term growth in book value is a key indicator of a well managed, growing company and a healthy balance sheet.
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