What it means
Accounting records most assets at what they cost, then reduces that figure over time to reflect use and ageing. The number that results is the book value, sometimes called carrying value or net book value.
It is an objective, verifiable figure, which is its strength, and it is not a measure of what the asset is currently worth, which is its limitation. A building bought thirty years ago may have a book value a fraction of its market value; a computer system bought two years ago may have a book value well above what it would fetch.
At the company level, book value is what the balance sheet says the owners would have if every asset were sold at its recorded value and every liability paid. Because the balance sheet records only certain assets at historical cost, book value typically understates the value of businesses whose worth lies in brands, customer relationships, technology or people.
A software company may trade at ten times book value; a bank, whose assets are mostly financial instruments carried close to fair value, may trade near one times. That ratio, price to book, is one of the oldest valuation tools.
A price-to-book ratio below 1.0 means the market values the company at less than its recorded net assets, which can indicate an undervalued stock, or a business whose assets are worth less than the accounts suggest, or one expected to earn returns below its cost of capital. Value investors have long screened for low price-to-book stocks; the measure is most meaningful for asset-heavy businesses such as banks, insurers, property companies and manufacturers.
Book value also matters in transactions. Sale agreements often set a price relative to net assets at completion with an adjustment mechanism.
Loan covenants may require minimum net worth. Impairment tests compare book value with recoverable amount and force write-downs when the accounts have become too optimistic.
In practice
Real-world examples.
Example
A bank's shares trade at 0.8 times book value after investors conclude that its loan book will suffer losses the accounts have not yet recognised.
Example
A technology company with book value of $2 per share trades at $60 because almost all of its value lies in software, brand and engineers that the balance sheet does not record.
Example
A company sells a subsidiary with a book value of $30 million for $50 million and reports a $20 million gain on disposal.
Think of it
“Book value is like the value of your car according to the Blue Book-it's an accounting estimate that may differ from what someone would actually pay for it.
Formula
Calculation
Book Value of an Asset = Cost minus Accumulated Depreciation (or Amortization) minus Impairment
Book Value of a Company = Total Assets minus Total Liabilities = Shareholders' Equity
Book Value per Share = Shareholders' Equity / Number of Shares Outstanding
Price-to-Book Ratio = Share Price / Book Value per Share
Worked example 1, an asset. A machine cost $150,000 four years ago and is depreciated straight-line over ten years with no residual value.
- Accumulated depreciation = 4 x $15,000 = $60,000
- Book value = $150,000 minus $60,000 = $90,000
- If the machine is sold today for $70,000, the company records a loss on disposal of $20,000
Worked example 2, a company. A listed industrial company reports total assets of $2.4 billion and total liabilities of $1.5 billion. It has 300 million shares in issue and the share price is $4.20.
- Book value = $2.4 billion minus $1.5 billion = $900 million
- Book value per share = $900 million / 300 million = $3.00
- Price-to-book = $4.20 / $3.00 = 1.4
Investors are paying 40% more than the recorded net assets, which is modest and suggests either that the assets are conservatively valued or that the company earns only moderate returns on them. If intangible assets and goodwill of $400 million are excluded, tangible book value is $500 million, or $1.67 per share, and the price to tangible book ratio is 2.5.Case study
Seen in the real world.
An investor screened for shipping companies trading below book value and found one at a price-to-book ratio of 0.5: its fleet was carried at $800 million and the market valued the whole company at $400 million. Before buying, she checked how the fleet's book value had been set. The ships had been bought at the top of the last shipping cycle and were being depreciated over 25 years, but broker valuations for comparable vessels had fallen 45% since purchase.
Adjusting the fleet to market value cut book value to roughly $450 million, and after deducting the debt secured on the ships, equity was closer to $380 million. The stock was not cheap; the book value was stale.
Six months later the company recorded a $320 million impairment and the price-to-book ratio jumped above 1.0 without the share price moving. The investor's rule afterwards was to treat low price-to-book as a question rather than an answer.
Watch out
Common mistakes.
- Treating book value as market value or liquidation value. It is an accounting figure based on historical cost.
- Comparing price-to-book ratios across industries. Asset-light businesses naturally trade at high multiples of book.
- Ignoring intangibles and goodwill. Tangible book value is often the more useful figure for assessing downside protection.
Questions
People also ask.
Why is book value different from market value?
Book value uses historical cost less depreciation and omits internally generated intangibles. Market value reflects expectations of future earnings.
Is a low price-to-book ratio a buy signal?
Sometimes, but it can also mean the assets are overvalued in the accounts or the company earns poor returns. Investigate why the ratio is low.
Can book value be negative?
Yes, when liabilities exceed assets, often after sustained losses or large buybacks funded by debt. The company may still operate if it can service its debts.
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