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Market value and book value are the terms in which most people get confused. This confusion isn’t about the similarity and the differences between the market value and book value.
But this confusion lies in the difference between the “book value of a company” and the “book value of a share” or the “market value of a company” and the “market value of a share”.
Instead of touching on the topic of market value, we’ll stick to our topic of book value.
The above heading is just for your understanding purpose. Over the internet, you would not find such long and detailed phrases.
The term “Book value” refers to “Book value of the company” while the abbreviation “BVPS” which stands for “Book value per share” is the synonymous phrase for “book value of a share”.
Book value
If a company declares that it is gonna liquidate soon then it doesn’t mean that the money that the investors invest in that company will wipe off with its liquidation; they’ll surely get their investment back, but how much?
The answer to this question is whatever the book value would be.
Before liquidation, the company would sell its all assets and then pays its all debts, the money with which it left; is the book value of the company.
So, the book value is the net asset value (Total assets – Total liabilities) of the company.
How is Book Value Calculated?
BVPS
Isn’t this term very simple? Divide the book value, which you would calculate from the aforesaid formula, by the total number of shares and whatever the answer would come, it would be your book value per share.
It isn’t that simple.
Because in the example of the liquidation event of the company above, we’ve just discussed that the shareholders would get their money back.
But you need to know that two types of shareholders invest in a company; one is common shareholders and the other one is preference shareholders.
And you should also know the fact that the latter one is ranked higher than the former during liquidation.
So, it would be great if we exclude the preferred equity from the shareholder’s equity for calculating the BVPS.
And in the denominator we will take the total quantity of outstanding shares which refers to the shares available in the market to trade: not the shares which are held by the promoters as they’re not tradable.
How BVPS is used in the Stock Market?
Apart from the fact that BVPS is shareholder’s equity per share. BVPS is used by the investors in the analysis part also in the following way:
- Evaluating stock price
Yeah! BVPS does help us to evaluate any company’s stock price. Evaluation means the value of the stock, whether it is overvalued or undervalued.
In this evaluation process, we compare the book value of the share of the company with its current market price (share price).
- BVPS > Share price ⇒ Stock is undervalued.
- BVPS < Share price ⇒ Stock shouldn’t be considered overvalued because it is normal for a stock that its share price is greater than its book value.
- Price to Book value ratio
Generally, we call it the P/B ratio which is the ratio of price per share to the book value per share. i.e. Share price: BVPS
Observations:
- Companies with high tangible assets like oil & manufacturing companies have a lower P/B ratio.
- Companies that are in the IT field which have less tangible assets and more intangible assets have a higher P/B ratio.
- One shouldn’t compare the P/B ratio of different sectors’ companies while doing fundamental analysis like comparing technology companies with the companies which are in the manufacturing industry. Because, surely, their P/B ratios will differ by a wide range due to their holding of tangible assets.
How to increase BVPS
A company can use the following methods to increase book value per share:
- Share buyback
The share buyback is a corporate action in which a company repurchased its share from the shareholders due to various reasons.
If the company would buy back its shares then the number of outstanding shares will decrease
And that’s how the denominator in the formula of BVPS (=Assets – liabilities/no. of outstanding shares) will decrease and ultimately BVPS would increase.
- Increase assets and reduce liabilities
Remember the formula again, BVPS (=Assets – liabilities/no. of outstanding shares)
Now keep the denominator constant as we’re not talking about share buyback i.e. decreasing the outstanding shares. If you increase the assets or decrease the value of liabilities in the numerator, ultimately the BVPS would increase.
This question doesn’t make sense in itself more than what this question is doing in this article. It is here because the investors or I should say learners are asking this frequently over the internet.
There isn’t any parameter like “good book value per share” because it depends on the industry as we’ve just discussed above in the segment of P/B ratio.
If it is a company in the capital-intensive industry then it would have more tangible assets and then the book value per share would be more and vice-versa.
So, consider the P/B ratio instead of checking only BVPS while doing stock analysis.
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