Book Value and Market Value of Shares
When trading in stocks, it is always good to evaluate a company and its performance before you invest. This helps you to understand whether you are backing the winning horse.
When it comes to evaluating companies, there are two metrics that you can use – the book value and the market value. Both these values are different and have different indications for investors.
So, let’s understand each value and its importance in investment.
Understanding Book Value
Book value literally translates into the value of a company’s book or its financial statements.
The book value of a company is like its shareholder’s equity. It is the amount that the shareholders would get if the company were to be liquidated. It is calculated using the formula:
Book Value = Total Assets – Intangible Assets – Total Liabilities
So, for instance, the balance sheet of a business shows total assets of Rs. 100 crores, intangible assets of Rs. 5 crores and total liabilities of Rs. 65 crores, the book value would be calculated as follows –
Book value = Rs. 100 crores – Rs. 5 crores – Rs. 65 crores
= Rs. 30 crores
If the company had 3 crore outstanding shares, i.e., the number of shares trading in the market, the book value per share would be Rs. 30 crores / 3 crores = Rs. 10.
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Understanding Market Value
Market value, on the other hand, is the market capitalization of the company. It is the value at which its shares are being traded in the market. The formula for calculating the market value is as follows –
Market Value = Market Price Per Share X Total Number of Shares Being Traded in the Market
So, in the above example, if the market value of each share is Rs. 15, the market value of the company would be Rs. 15 * 3 crores = Rs. 45 crores
Importance of Book Value and Market Value for Investments
Both book value and market value can help you ascertain the value of a company. However, each of these values has its respective relevance to investment decisions. Here’s how –
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Book Value and Investments
The book value gives you a fair idea of what the company is worth in financial terms. It shows the amount that you stand to get in case of a company’s liquidation.
If the book value of a company is higher than its market value, it means that its stock price is undervalued. This is a basic tenet of value investing. Since the stock is undervalued, you can buy a larger volume. So when the company’s value increases, you can stand to make considerable gains.
So, when investing, consider the book value. Choose stocks whose book value is higher or closer to their market values.
That being said, book value works best for companies that have considerable fixed assets and investments at their disposal. For companies engaged in the IT sector, most of the assets are in intangible form. Since book value excludes the value of intangible assets, the value of the company may not be correct.
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Market Value and Investments
Market value helps you make investment decisions based on how the stock is trading. If the market value of a company is high, it shows increased investor confidence. Investing in such stock can give you good returns.
On the other hand, if the market value is higher than the book value, it shows that the company is overvalued. One correction, and you might make a loss.
Also, Read – Important Ratios in Stock Market
Difference Between Book Value and Market Value
Here is a comparative table showing the differences between the book value and the market value of a company –
Book Value |
Market Value |
| The book value is calculated using absolute figures in the balance sheet of the company. | The market value is calculated based on the current market value of the company’s shares. |
| The book value does not change constantly. | The market price per share depends on a lot of variables like market sentiments, demand and supply, socioeconomic conditions, etc. It keeps on changing constantly, thereby changing the market value too. |
| The book value denotes the shareholders’ part of the company’s assets. | The market value denotes the price traders are willing to pay for the stock. |
| Book value can be calculated from the financial reports of the company that are issued quarterly and annually. | The market value can be calculated anytime that you want to. |
| Book value is based on the balance sheet of the company. Therefore, the value could be outdated. | The market value is always up-to-date. |
Takeaway
It is always prudent for investors to factor in market and book values together. A single value alone usually doesn’t give the right picture. Choose stocks whose book values and market values are in tandem with each other.