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Although investors have many metrics for determiningthe valuation of a company"s stock, two of the most commonly used are book value and market value. Both valuations can be helpful in calculatingwhether a stockis fairly valued, overvalued, or undervalued. In this article, we"ll delve into the differences between the two and how they are used by investors and analysts.
A company"s book value is the amount of money shareholders would receive if assets were liquidated and liabilities paid off.Themarket valueis the value of acompany according to the markets—based on the current stock price and the number of outstanding shares.When the market value is less than book value, the market doesn"t believe the company is worth the value on its books.A higher market value than book value means the market is assigninga high value to the company due to expected earnings increases.
The book value of a stock is theoreticallythe amount of money that would be paid to shareholders if the company was liquidated and paid off all of its liabilities.As a result, the book valueequalsthe difference between a company"s total assets andtotal liabilities.Book value is also recorded as shareholders" equity. In other words, the book value is literally the value of the company according to its books (balance sheet) once all liabilities are subtracted from assets.
The need for book value also arises when it comes to generally accepted accounting principles (GAAP). According to these rules, hard assets (like buildings and equipment) listed on a company"s balance sheet can only be stated according to book value. This sometimes creates problems for companies with assets that have greatly appreciated—these assets cannot be re-priced and added to the overall value of the company.
Calculating The Book Value of Bank of America Corporation (BAC)
Below is the balance sheet for the fiscal year ending for 2017 according to the bank"s annual 10K statement.
Assets totaled $2,281,234trillion.Liabilitiestotaled $2,014,088trillion.The book value was $267,146 billion as of the end of 2017.
In theory, if Bank of America liquidated all of its assets and paid down itsliabilities, the bank wouldhave roughly$267 billion left over to pay shareholders.
Themarket valueis the value of acompany according to the financial markets. The market value of a company is calculated by multiplying the current stock price bythe number of outstanding shares that aretrading in the market. Market valueis also known asmarket capitalization.
For example, as of the end of 2017, Bank of America hadover 10 billion shares outstanding (10,207,302,000) while the stock traded at $29.52, making Bank of America"s market value or market capitalization $301 billion (10,207,302,000 * 29.52).
The book value is literally the value of the company according to its books (balance sheet) once all liabilities are subtracted from assets.
How Book Value and Market Value Are Interpreted
When the marketvalue of acompany isless than itsbook value,it may mean that investors havelost confidence in the company.In otherwords, the market maynotbelieve the company is worth the value on its books orthat there areenough future earnings.Value investorsmight look for a company where the market value is less than itsbook value hoping that the market is wrong in its valuation.
For example, during the Great Recession, Bank of America"s market value was below its book value. Now that the bank and the economy have recovered, the company"s market value is no longer tradingat a discount to its book value.
When the market value is greater than the book value,the stock market is assigninga higher value to the company due to theearnings powerof the company"s assets. Consistently profitable companies typicallyhave market values greater than their book values because investors have confidence in the companies" abilities to generate revenue growth and earnings growth.
When book value equals market value, the market sees no compelling reason to believe the company"s assets are better or worse than what is statedon the balance sheet.
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The Bottom Line
Book value and market value are two fundamentally different calculations that tell a story about acompany"s overall financial strength.Comparing the book value to the market value of a company can also helpinvestors determinewhether a stock is overvalued or undervalued given its assets,liabilities, and its ability to generate income. However,with any financial metric, it"s important to recognize the limitations of book value andmarket value and use a combination offinancial metrics whenanalyzing a company.