Valuation of a company is a critical task and requires a lot of understanding about different industries and sectors. Good understanding of valuation fills confidence among the investors to buy and sell stocks.
There are various measures on which investors take the decision of buying or selling the stocks, some important measures are Market value and Book Value.
“Market Value” is the overall value which is assigned by the investors to a company on a particular date (ongoing price of a share). It is calculated by multiplying the market price per share with the number of shares. Market value per share is the price at which one can buy or sell a stock in the market.
For example, if the company has 10M shares and each share is worth $30, then the market value of company will be equal to $300M (10M Shares * $30). Market Value can be more than the book value or less than the book value.
As in the case of book value, it has nothing to do with the value of the assets of the company,
There are many factors that affects the market value of a company such as profitability, performance or a simple news can affect its market value.
“Book Value” is a measure which is used by the shareholders in an organization to evaluate the level of security which is associated with each share after paying all the debts. The book value of equity is a factor which is used by the investors to determine whether price of Stock is undervalued or overvalued.
The book value of a company is the difference between value of its total assets and total liabilities – for example, if the value of all assets equals $100M and the value of all liabilities equals 90$, thus the book value of company equals $10M ($100M – $90M).
On the company’s balance sheet, it is shown as shareholders’ equity. By comparing Book value of a share with its Market price, an investor gets an idea if the company is underpriced or overpriced.
Difference Between Book Value and Market Value
|Basis of Comparison||Book Value||Market Value|
|Meaning||Book value means the value which is recorded in the books of the firm for any asset. It is the actual worth of asset or company.||Market Value is the maximum price at which an asset or security can be bought or sold in the market. It is the highest estimated value of asset or company.|
|Reflects||Firm’s equity.||Current market price.|
|Basis of calculation||Tangible assets||Tangible and intangible assets.|
|Change||Book Value changes annually.||Market value fluctuates every now and then.|
|Availability||Easily available||Not easily available|
Relationship Between Book Value, Market Value and Value Of A Company.
Following are three principles that shows the relation between Book Value and Market Value:
- Book Value is greater than Market Value: It is a situation where the value of a company in the market is less than it’s stated value or net worth. If this is the case then it is usually because the market has lost trust and confidence in the ability of the company’s assets to generate future profits and cash flows. Value investors often investigate such companies in faith that the market approach turns out to be incorrect.
- Market Value is greater than Book Value: The market gives high value to the company due to the earning power of the company. Nearly all profitable companies will have their market values greater than book values.
- Book Value equals Market Value: In this situation, there is no appealing reason to believe that the company’s assets are good or bad than what is mentioned on the balance sheet.
Price To Book Value Per Share (P/BV)
Price to Book Value (P/B) is considered to be the most relevant valuation measure in order to evaluate the performance of a stock.
The Price-to-Book ratio (P/B Ratio) is a ratio which is used to compare the market value a stock to its book value. It is calculated by dividing the price of the stock (closing price) by book value per share. It is also called “Price-Equity ratio”.
FORMULA: P/B Ratio = Market Price per Share / Book Value per Share.
What Does P/B Ratio Indicates?
Usually, P/BV ratio of the companies of the services industries like software and FMCG are high as compared to the companies in the sectors like auto, engineering, steel and banking. The reason behind this is due to sectors such as software and FMCG have less fixed assets on their Books of Accounts and due to which the P/BV may not calculate appropriate value of the company. On the other hand, businesses with huge capital investment such as auto and engineering have a large amount of fixed assets and investments on their Balance Sheet. P/BV is a good measure for valuing stocks for sectors which require huge capital investments.
P/B ratio can be less than and more than 1. If it is less than 1 then it can be due to the following 2 reasons-
- The assets of the company are overvalued.
- Returns on the assets of the company are poor.
If P/B ratio is high then market believes that:
- The company’s assets to be undervalued.
- The company is and expected to earn in the future a high return on its assets.
Both Market Value and Book Value are important factors for the investors to make investment. Market Value provides indication that the company’s financial position is good. Book Value indicates the current position of a company and ignores future growth and possibilities. By combining both the concepts we can evaluate whether a stock is valued correctly or not, which can help the investors in making the investments.
Despite the fact that Price to Book ratio is an important factor for the investors but it is more useful for the novice investors. Don’t take buy or sell decision only on the basis of price to book ratio, consider all the parameters and other factors before investing.