Book value and market value
are two terms often used in finance, and particularly when one deals with
listed securities.
This article will clarify the
two terms, when they are used and the differences between them. Book value for
an asset or company can be defined from the balance sheet, as assets less
liabilities. This will give us book value, or equity value, or net worth. Book
value implies the value of the company on its books (the balance sheet), also
known as accounting value.
Market value is the value of
the company according to the stock market that is the current price of the
stock at which the stock is traded. It is found by taking the number of share
outstanding (traded) times the current market price. This is the market value,
or the value of the business.
Market value has more meaning
in that it implies that it is the price one pays to own part of the company
regardless what its book value is. Book value may sometimes not give us the
actual value since, for example, if a company owns assets (fixed assets), those
assets are depreciated over time. Hence their values are not the same. That is
why market value and book value differ most of the time.
On any given day a company’s
market value fluctuates in relation to its book value. The way we ascertain
this is by the price to book value, P/B ratio.
The P/B ratio is determined
by share price divided by book value per share (BV/share), where BV/share is
equal to shareholders equity / number of shares outstanding. If P/B =1, then it
implies that Book value (BV) and market value (MV) are equal.
If P/B is <1, it implies
that MV is less than BV. If P/B is >1, it means that MV is greater than BV.
A case in point is Coca Cola
with a P/B ranging between 6 and 7 (Dec 31, 2015 and Dec 31, 2014,
respectively). This implies that its market value is 6 to 7 times larger than
book value as seen on the balance sheet. The data are taking from https://www.stock-analysis-on.net/NYSE/Company/Coca-Cola-Co/Valuation/Ratios#PBV.
For the soft beverage industry the P/B is 8.13 as of January 2016 from http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/pbvdata.html.
Coca Cola has valuable assets
like a brand name, distribution channels that allow the company to make money.
The market values the company’s business as being worth much more that its
value on the balance sheet. According to https://ycharts.com/companies/KO/profit_margin
the net profit margin for Coca Cola was 14% as of March 2016, which is
supported by the above analysis. Net
profit margin is the ratio of net profit to revenue, and indicates how much
profit a company can generate for every dollar it takes in.
If we switch to a different
industry (financial) and look at Wells
Fargo, one of the oldest banks in the United States, its P/B is 1.5 (1.44)
according to https://ycharts.com/companies/WFC/price_to_book_value
. What this means is that the market values the company close to book value.
Financial companies, such as banks, hold assets that consist of loans, liabilities
(deposits), cash, and investments. These assets are easily valued. Banks hold
good loans and bad loans, and during a financial crisis, like that of the
banking crisis in the US, their market values fall below book value.
If a company generates income
by the wise use of its assets, then its return on assets is high, which in
turn, implies that market value is > than book value.
