Book value, also known as “Shareholders Equity” is the difference between the company’s total assets minus all of its liabilities. Another term is intrinsic value. If a company were to sell every asset they have and pay off all their debts the amount left over is the book value.
The “Explain Like I’m Five” version is: Tommy has ten dollars but owes his parents three dollars, his book value is seven dollars.
Book Value of a Company = Total Assets – Total Liabilities
Pretty simple right? Let’s talk more about where to find this information. Luckily in this day and age, the internet can provide an ample amount of resources and information. You can probably find this information without analyzing balance sheets yourself. However, it’s beneficial to learn how to read and understand one. You may not always find the information you’re looking for through alternative sources or brokerages.
There are a lot of terms and different types of liabilities that you should get familiar with. Let’s do some of it together. Below is a consolidated balance sheet from Amazon between the years 2016 and 2017.
The total assets are outlined in green at the top of the balance sheet. One thing you may notice in the asset’s column is the word “goodwill.” That is when a company purchases another company and is known as an intangible asset. It can be calculated in a number of ways but we will leave that for another discussion.
The combined balance sheet had the totals of their current liabilities excluding their long-term debt. I added them together to show how we end up with the number for shareholder equity or “Book Value” highlighted in green at the bottom. You can see that shareholder equity has increased from the previous year. A consistent increase in book value is a bullish sign that many investors look for.
Where to find company filings
All of this is public information! You are able to get access directly from the SEC. They have a great article that goes over the different types of forms and how to use their research tools.
Why knowing the book value is worthwhile?
If you’re going to invest in a company you want to be sure they are not burning through money like a teenager at the mall. Understanding the book value of an asset can save you from making serious financial mistakes. Many “Value Investors” use the book value to spot companies trading at deep discounts. Allowing them to purchase their assets for less than they’re worth.
Some downfalls of book value
Remember the “Goodwill” section on the balance sheet that we looked at earlier? Well to really find out if that is being calculated correctly, you’ll need to do more homework. Book value doesn’t do well with intangible assets. You may think you are buying below book value, but the assets can be artificially inflated.
Price to Book Ratio (P/B Ratio)
You now know how to get the book value of a company. It’s time to compare it to the current market price per share. This formula is known as the “Price to Book Ratio”
Dividing the market price per share by the book value price per share will give you the P/B Ratio. To get the “Book Value Price Per Share” you would take the book value of the company and divide it by the number of common shares outstanding. Generally, anything under 1.0 is considered undervalued. However, it depends on the company and the bigger picture of the industry its in.
Some companies with a P/B under 3 could also be undervalued. It will also help you identify if the company is being valued too high. Companies with a high P/B could leave you with little or nothing if they were to file bankruptcy.
It’s also beneficial to compare the P/B with other companies in the same industry, current cash flow, and the return on equity (ROE). By now you should hopefully have a good understanding of Book Value and how to apply it in an investment strategy.