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Book Value Vs Market Value- Know the difference and usage of both
Meaning of Book Value:
Book value is the value of a company that is reflected in its books of accounts. Book value can be tampered with, but if the accounts are prepared as per rules, it give the real value of the company without being subjected to any external factor like perceived value or liquidity in the markets.
Meaning of Market Value:
Market value is the price of a stock, or for that matter any asset class, as determined by the market. Multiplied by the number of shares, it comes to represent the total market cap of a company. In other words, it is also the fair value of a stock discovered by the market. At the same, in case of a stock, its value constantly changes as it exchanges hands between buyers and sellers.
Book Value Vs Market Value
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Book Value |
Market Value |
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It is the value of a stock as reflected in a company’s own books based on accounting principles |
It is the value of a stock determined by the market |
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It is the cost paid to buy an asset that also gets adjusted for inflation year after year |
It is the value determined in an open market that may be less than, equal to or greater |
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Gives the real value of the stock, fair value of the company |
The value of the stock as perceived by the market, with the value changing constantly |
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Roughly equals the value the shareholders will get if the company was liquidated and liabilities paid off |
Is relevant only as long as the stock is traded, has no relevance in case of liquidation |
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Book value changes with a lag, say a quarter or mostly a year according to the balance sheet |
Market value changes constantly |
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If the book value is more than the market value, generally then the company is undervalued |
No direct co-relation but investors expect market value to be higher than book value |
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Based solely on the previous quarter or year’s numbers/performance, no relation to future |
Based on future earnings potential of the company as well as market sentiment |
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Is a more conservative calculation given it’s based on historical and actual performance |
Can be unrealistic as it’s built on expectations which may or may not have an actual basis |
When to Consider Book Value and Market Value?
Investors should look at both book and market values while making investment decisions. Book value is useful when the company has large fixed assets, say a capital equipment manufacturer, an infrastructure, or a real estate company. For services companies that have fewer fixed assets and mostly rely on intangibles or labor/intellectual capital, book value may not give the correct picture of the health of the company. The book value of a company excludes the value of intangible assets.
Book value is good at assessing the fundamental value of a company's assets. It's a good indication to shareholders about how much they would receive if the company were to go into liquidation.
If the market value is significantly higher than the book value, it indicates high investor confidence in the company's future. On the other hand, if the market value is lower than the book value, it may signal financial distress or undervaluation.
Industry Level Usage of Book Value and Market Value
Book value is a useful concept for companies with high spending on capital equipment and those that have high fixed assets like real estate and infrastructure companies. Companies use book value to determine the value of assets to calculate depreciation and amortization. In the case of real estate where the market value can also fluctuate wildly, a book value gives a better picture of the asset quality and its value.
Market value represents the perceived value of a company based on its future growth potential. In IT, AI startups, research-oriented, and pharmaceutical sectors, a book value may not give a fair assessment of the company since they are driven by the high quality of their workforce. The value of their intellectual capital and patents is high, which is not captured in the book value.
How to calculate P/E ratio
To calculate a company’s P/E ratio, one needs to know its market price and its earnings per share. To calculate EPS, we subtract preferred dividends from the net income (net profit) of the company. The resulting number is then divided by the number of outstanding shares of the company. This is the EPS, which basically means undistributed profit of the company on per share basis.
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