Book value vs market value – Why are they both equally important

Stock markets are commonly viewed as gambling markets. You don’t know what the next day will bring. If you are a millionaire today, you can be a pauper tomorrow, depending on your decision-making skills.

Book value vs market valu

Though, do you know what’s true of all? That it is just a game of mind. If you are fully armed with your research, the probability of making a wrong decision deflates. The key to good research is knowledge about financial terms. If you couldn’t differentiate between book value and market value, how would you make a better investment decision? Therefore, we developed a comprehensive guide for book value vs. market value to make your investments fruitful.

Key Takeaways

  • Book value is the amount that the shareholders get when the company dissolves.
  • Market value is based on the outstanding shares and stock prices on which the market is currently trading.
  • If the market value is low and the book value is high, stocks of that company are sold at higher prices.

Book Value

Book value is the shareholder’s equity. It is the amount that the shareholders get when the company dissolved or paid its liabilities off. In financial terms, it is the value we get when we subtract the company’s total assets from total liabilities. You can easily determine a book value of a company from its balance sheet.

To make it easier, let’s assume that An XYZ company has total assets of $10 million, out of which $5 million are intangible assets and the rest are tangible. The company has a liability of $2 million. In that case, the company’s book value will be $3 million. {Book value = intangible assets ($5) – liabilities ($2)}

Apart from investing in stock, the need for Book value arises when people compile their financial statements at the year’s end. According to the law in the United States, a company’s physical assets, for instance, equipment and buildings, will only be listed based on their book value. Several companies face issues filing their asset’s book value because even if their assets have appreciated over the years, they have to write down the book value. They cannot be priced based on their market value.

Which industries use Book Value the most?

Mostly, companies with physical assets, such as construction companies,  Metal factories, Equipment manufacturing, etc., in abundance use book value more than service companies like software houses, agencies, and digital firms. Service companies’ assets lie in their intellectual property.

Secondly, it is used as a decision-making tool for making investments. By just checking the balance sheet, you can determine the worth of the company. This will help you determine whether a company has the potential to grow or not and how well it’s managing its assets.

How to calculate Book Value?

For instance, let’s calculate the book value of Bank of America Corporation. A balance sheet is prepared at the fiscal year’s end to file with a 10k statement.

Assets Totaled $2,281,234 Trillion
Liabilities Totaled $2,014,088 trillion
Book Value $267,146 billion

If the Bank of America Corporation pays off all the liabilities and liquidates all the assets, they will be left with $267 billion on hand to pay their shareholders.

Market Value

Just as its name suggests, its value is based on its position and performance in the financial markets. It is also called Market Capitalization. In layman’s terms, it is the value of a company that you have to pay if you buy out all the outstanding shares at its current share price in the market.

Unlike book value, market values are unpredictable. Their prices fluctuate based on the market conditions. Since investors and traders constantly buy and sell the stocks, thereby the prices don’t remain the same.

Either it’s several new stocks or share prices, these numbers don’t fluctuate considerably in the stock market. Big changes happen only if there is good or bad news in the market regarding that particular industry in which the stocks are being traded. The number of stocks changes when the company buybacks its shares or issues more stocks.

Since every corporation sells its stocks regardless of its business type, market value is essential for every business type. For instance, A real estate company like Simmon Property and a service company like Verizon Communications have their stocks available to trade.

How to calculate Market Value?

Suppose if the Bank of America has $5 million outstanding shares, and the trade price of each stock is $30. It means the market value of it would be $150 million. Market value = Outstanding shares ($5 million) x per stock price ($30).

Outstanding shares $5 million
Per stock price $30
Market Value $150 million

Book Value vs Market Value

Following, we have listed the key differences between book value and market value.

Book Value Market Value
●        Book value is the company’s true intrinsic value that is calculated from a balance sheet considering the amounts of assets and liabilities it owes.

●        The book value is known to the company’s investors only. It can only be determined through the financial statements that the company files every year.

●        Book value takes some effort to calculate. An investor must have knowledge of accounting practices, asset depreciation, assets claims, and liquidation. That along with knowledge of tax laws, book Value is calculated.

●        Book value produces insightful digits that the top management uses to determine the company’s operations. It represents the actual health of the company.

●        On the other hand, market value is the investor’s perception of a particular company that how demanding their business is. Typically, investors use intangible assets, algorithms, AI, and future growth potential to determine a company’s market value.

●        Whereas the market value information of a business is readily available to everyone (who are not part of the organization).

●        On the contrary, Market Value is easier to calculate. Market cap figures are conveniently available on numerous stock listings websites and corporate profiles.

●        Market Value is a false representation of a company’s worth. For instance, if a rumor spreads about an XYZ company acquisition a well-known company, the share prices of the XYZ company will rise even before the acquisition is made.

 

The bottom line

The book value and market value represent two different conditions of a company. One is the mirror image of the internal health of a company, while the other one is the reflection of investors’ perception. However, to make the best investment decision, one must know both terminologies. For instance, if the share is currently priced at $190, but its book value is $50, you would know it is not worth investing as it will fall after the hype is over. Or, if you are an expert trader, in that case, you will do a careful analysis of the company’s cash flows and future growth potential that whether the share price will rise or fall further. Now use this knowledge, secure your investment and earn big dividends.

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