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The Difference Between Book and Market Value
Book value is the price paid for an asset. It never changes as long as the asset is owned. Market value is the current price at which the asset can sell.For example, a home bought 10 years ago for $300,000 will retain that $300,000 book value for as long as the investor owns it. If the house will sell today for $500,000, that’s its market value.Book values are useful for tracking profits and losses. The difference between an investment’s book and market values reveals the profit or loss incurred.Generally accepted accounting principles require a company’s balance sheet to list hard assets, such as buildings and equipment, according to their book values. This rule can be problematic if a company’s assets have greatly appreciated, since the assets cannot be re-priced and added to the company’s overall value.For more information, see What’s the Difference Between Book and Market Value?
Reviewed by Michael J BoyleFact checked by Amanda Bellucco-ChathamReviewed by Michael J BoyleFact checked by Amanda Bellucco-Chatham
Book Value vs. Market Value: An Overview
Although investors have many metrics for determining the valuation of a company’s stock, two of the most commonly used are book value and market value. Both valuations can be helpful in calculating whether a stock is 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.
Key Takeaways
- A company’s book value is the amount of money shareholders would receive if assets were liquidated and liabilities paid off.
- Market value is the value of a company according to the markets based on the current stock price and the number of outstanding shares.
- When the market value is less than the 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 assigning a high value to the company due to expected earnings increases.
- When using book value and market value to evaluate companies against each other, it’s important to compare companies within the same industry.
Book Value
The book value of a stock is theoretically the 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 value equals the difference between a company’s total assets and total 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 Book Value
Below is the balance sheet for the fiscal year ending in 2023 for Bank of America from the bank’s annual report.
- Assets totaled $3.18 trillion.
- Liabilities totaled $2.89 trillion.
- The book value was $290 billion as of the end of 2023.
In theory, if Bank of America liquidated all of its assets and paid down its liabilities, the bank would have roughly $290 billion left over to pay shareholders.
Market Value
The market value is the value of a company according to the financial markets. The market value of a company is calculated by multiplying the current stock price by the number of outstanding shares that are trading in the market. Market value is also known as market capitalization.
For example, as of May 29, 2024, Bank of America had 7.82 billion shares outstanding while the stock closed at $38.72, making Bank of America’s market value or market capitalization $303 billion (7.82 billion x 38.72).
Special Considerations
When the market value of a company is less than its book value, it may mean that investors have lost confidence in the company. In other words, the market may not believe the company is worth the value on its books or that there are enough future earnings.
On the other hand, value investors might look for a company where the market value is less than its book 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. As of 2024, the company’s market value is no longer trading at a discount to its book value.
Important
Book value and market value are just two metrics to evaluate a company. Others include the debt-to-equity (D/E) ratio, earnings per share (EPS), price-to-earnings (P/E) ratio, and the working capital ratio.
When the market value is greater than the book value, the stock market is assigning a higher value to the company due to the earnings power of the company’s assets. Consistently profitable companies typically have 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 stated on the balance sheet.
Book value and market value are two fundamentally different calculations that tell a story about a company’s overall financial strength. Comparing the book value to the market value of a company can also help investors determine whether a stock is overvalued or undervalued given its assets, liabilities, and its ability to generate income.
With any financial metric, it’s important to recognize the limitations of book value and market value and use a combination of financial metrics when analyzing a company.
Is Book Value the Same as Fair Value?
The book value of an asset refers to its cost minus depreciation over time. It is the value of an asset based on its balance sheet. The fair value of an asset reflects its market price; the price agreed upon between a buyer and seller.
Is Book Value a Good Indicator of a Company’s Value?
Yes, book value can be a good indicator of a company’s value. If the book value per share is higher than its market value per share then it can indicate an undervalued stock. If the book value per share is lower than its market value per share, it can indicate an overpriced, or overvalued stock.
What Does a Negative Book Value Mean?
A negative book value means that a company’s liabilities are greater than its assets. This indicates a company is possibly insolvent. This, however, does not mean that a company is a bad investment. One would need to dig deeper to understand why the book value is negative.
The Bottom Line
Book value and market value are two different ways to value a company. Book value focuses on the balance sheet and compares a company’s assets to its liabilities to determine how much equity would be left over after it fulfilled all of its obligations.
Market value is focused on a company’s share price, so it focuses more on a company’s perceived worth and multiplies the number of shares outstanding by its share price. The two metrics can be compared to each other to help determine whether a stock is overvalued or undervalued.
Read the original article on Investopedia.