What is Book Value per Share
Book value per share is simply (Common Stockholder’s Equity / Number of Shares of Common Stock)
If there are no preferred shares outstanding, Total Stockholder’s Equity can be used in place of Common Stockholder’s Equity.
The Balance Sheet is expressed as the following:
Assets = Liabilities + Equity
Therefore, Equity is simply Assets – Liabilities of a company and is comparable to the concept of Net Worth.
How to Use Book Value per Share
One way to look at Book Value per Share is to consider what will happen if the company ceases all operations today.
Theoretically, the company can sell all its assets and pay off all its debt and liabilities. What remains is the Equity that is distributable to its shareholders.
Therefore, it makes sense to use book value per share as a measure of the value of the company to the shareholders. If the company shares are priced much higher than the book value per share, than the stock price might be too high for purchase. This will depend on the nature of the business the company is engaged in. For example, service industries leverage their employees’ expertise to generate revenues and are less dependent on physical assets such as plant, property and equipment. In these cases, the stock can be priced way above the book value per share of the company.
When reviewing the book value per share for valuation purposes, you should also keep in mind that the assets may not be valued close to what they might fetch in the market. The depreciation schedules used to approximate the decline in value due to the age and wear and tear of the asset are general in nature and may be off for the particular asset in question. We have had situations where the land holdings acquired over 200 years ago were completely depreciated and carried at zero book value on the balance sheet. In reality, this land was oil producing land and worth a significant sum.
Finally, even if you arrive at the appropriate book valuation that is very close to the market value of the assets, if the company were to undergo a forced liquidation and sell these assets at a firesale, they might fetch considerably less than your best estimate. So in most cases, the confidence level in the book value estimate needs to be married with the financial health of the company.
More Reading:
The Buffett Approach to Valuing Stocks
THE REAL SECRET TO BEATING THE MARKET BY 6% ANNUALLY
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