Book value vs market value - Key Differences

Book value and market value are fundamental ways to assess a company’s worth, but they come at it from two different angles. While book value is based on accounting data and the net value of a company’s assets, market value is shaped by investor sentiment and represents what the market is willing to pay for a company’s shares.

When used together, book value and market value can provide insight into whether a company’s stock is fairly priced or potentially undervalued or overvalued. In this article, we’ll explain how book value and market value are calculated and the key differences between the two.

What is a book value?

Book value is the value of a company based on its financial statements. It shows what a company would be worth if it sold all its assets and paid off all its debts and obligations. In simple terms, book value is the net asset value of a business, or what shareholders would receive if the company was liquidated today.

Book value formula

Book value can be calculated using a simple formula:

Book Value = Total Assets - Total Liabilities

Assets can include things like:

• Cash and short-term investments
• Accounts receivable
• Inventory and equipment
• Real estate or factories
• Intangible assets, like patents and trademarks, but only if they appear on the balance sheet.

Liabilities include obligations such as:

• Debt
• Accounts payable
• Deferred taxes
• Other financial commitments.

You can usually find book value on a company’s balance sheet listed as ‘shareholder’s equity’.

Book value example

Consider a company with $200 million in total assets and $160 million in total liabilities. To calculate its book value, you would use the formula above:

$200 million - $160 million = $40 million

In this case, the company’s book value is $40 million. That’s the net value shareholders would theoretically receive if the company liquidated everything and paid off all its debts.

Book value per share (BVPS)

Book value per share (BVPS) breaks down book value on a per-share basis, showing investors how much of a company’s net assets they get with each share of stock.

Here’s how to calculate BVPS:

BVPS = Book Value / Total Outstanding Shares

Outstanding shares include all shares held by shareholders, including both public and institutional investors as well as restricted shares.

For example, if a company has a book value of $40 million and 5 million outstanding shares, then:

BVPS = $40,000,000 / 5,000,000 = $8 per share

This means each share represents $8 of the company’s net assets.

Limitations of book value

Book value can be useful for evaluating a company, but it also has certain limitations.

Firstly, book value is based on a company’s financial statements. These are updated quarterly or annually, which means they may not reflect a company’s current conditions or recent changes in the company’s finances.

Secondly, book value depends heavily on accounting rules and adjustments. Things like depreciation and amortization can affect asset values in ways that aren’t always easy to understand. For example, a company that uses straight-line depreciation might overstate the value of older equipment.

Book value also doesn’t fully capture the real-world risks of liquidation. For example, a company might not always recover the full value of their assets, creditors might have first claim, and assets could be sold at steep discounts in a weak market.

Another limitation of book value is that it often leaves out, or underestimates, the value of intangible assets like brand reputation, software, or intellectual property. For tech-driven or service-based companies, this might make book value seem much lower than the company’s actual worth.

Finally, book value isn’t ideal for all industries. Companies that rely heavily on physical assets, like manufacturing or real estate, tend to have higher book values. On the other hand, companies that rely on human capital – like consulting, software or design – might have low book values even if they’re highly profitable.

What is market value?

Market value is the current price for an asset in the open market. In the context of companies, it refers to the total value of a company based on the stock market. It’s also known as market capitalisation or market cap.

Market value is a reflection of real-time investor sentiment and changes constantly as the company’s share price moves. In some situations, the market can undervalue or overvalue a company based on hype, fear, or short-term news – which is why investors often compare market cap with book value to get a more balanced view.

Market value formula

Market value is based on what investors are willing to pay for a company’s shares at any given moment. Here’s how it’s calculated:

Market Value = Current Share Price x Total Outstanding Shares

Because stock prices fluctuate throughout the day, a company’s market value is always changing. The outstanding shares, however, will remain stable unless a company issues new shares or buys some back.

Market value example

Let’s say a company is trading at $30 per share and has 1 million outstanding shares:

Market Value = $30 x 1,000,000 = $30 million

This means the market believes the company is worth $30 million at that moment.

Limitations of market value

Market value reflects what investors are willing to pay for a company right now, but it doesn’t always reflect a company’s actual worth. Like book value, there are certain limitations to this metric.

Firstly, market value is based on investor sentiment. The stock price of a company can rise or fall sharply based on news, hype, fear, or rumors, sometimes without any real change in its business fundamentals. Even large, stable companies can see their stock prices swing from 3% to 5% in a single day, meaning it’s not always a reflection of long-term value.

History also shows us that markets can get carried away. During the dotcom boom, for example, companies were trading far above their actual value. In downturns, like the inflation era of the 1970s, market values for many companies dropped below their book values. These experiences show us that relying on market value alone might not provide the full picture.

Key differences between book value and market value

By now, it should be clear how market value and book value measure a company’s worth from entirely different angles. Let’s recap some of the key differences between them:

• Basis of calculation: Book value is based on accounting data while market value is based on the current stock price in the market.
• Influencing factors: Book value is influenced by actual financials like assets and liabilities. Market value, on the other hand, is influenced by investor sentiment, future growth prospects, news, and market trends.
• Stability: Book value is more stable compared to market value, which is highly volatile and changes constantly during market hours.
• Accessibility: Market value is easily found on financial news sites or trading platforms (like Metatrader), while book value can be found in balance sheets and reports. Book value can also be adjustable and might require an understanding of a company’s accounting practices.

Traders and investors often combine both book value and market value to get a full picture of a company’s worth. There are three possible scenarios when doing this:

Book value is greater than market value

When book value is greater than market value, it can be a sign that investors have lost confidence in a company, whether due to poor performance, legal troubles, or other factors.

It can also indicate that a company is undervalued. Some value investors see this as an opportunity to buy a stock for less than its net worth, hoping that the market will eventually correct the gap.

Market value is greater than book value

It’s more common for a company’s market value to be higher than its book value. This suggests that investors are optimistic about a company’s future and its growth, innovation, and earnings potential.

Profitable and fast-growing companies usually trade above their book value, however it can also indicate that a stock is overbought or overvalued.

Book value is equal to market value

When a company’s book value is equal to its market value, it suggests that the company’s assets and liabilities are priced fairly – neither overhyped nor undervalued.

Price-to-book ratio

The price-to-book (P/B) ratio is a simple way to compare a company’s market value to its book value. It can help investors identify undervalued or overvalued stocks based on how they’re priced on the market relative to a company’s net assets:

• Low P/B ratio: A P/B ratio less than one means a stock is trading for less than its book value, potentially signalling a bargain.
• High P/B ratio: A P/B ratio higher than one means the market value is higher than book value, indicating potential overvaluation.

How to calculate P/B ratio

The P/B ratio can be calculated as:

P/B Ratio = Market Price per Share / Book Value per Share

It can also be expressed as:

P/B Ratio = Market Price / Book Value

P/B ratio example

Consider a stock trading at $50 per share and its book value per share is $25.

P/B = $50 / $25 = 2.0

This means the market values the company at twice its book value. Now let’s say the stock’s price drops to $20 per share.

P/B = $20 / $25 = 0.8

The stock is now trading below its book value, which might attract value investors looking for a deal.

How investors use book value and market value

Book value and market value offer two different angles for evaluating a company. When used together, they can provide investors with a more complete picture of whether a stock is fairly priced and if it has long-term potential.

Investors often use book value when assessing a company’s financial health. Since it reflects the net assets on a balance sheet, it gives investors an accounting-based view of what a company owns versus what it owes.

On the other hand, market value is often used when investors want to gauge things like growth potential, earnings expectations, and overall market sentiment. It can provide insight into how the market perceives a company's future prospects.

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