Although investors have many indicators to determine a valuation of shares of the company, two of the most commonly used book value and market value. Both of these estimates may be useful when calculating whether the shares are 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.
The Carrying Value Of
The book value of a stock is theoretically the amount of money that will be paid to shareholders if the company was liquidated and paid on its liabilities. As a result, the carrying value is equal to the difference between total assets and total liabilities. The carrying amount is also reflected as equity. In other words, the book value is literally the value of the company according to its financial statements (balance sheet) after all liabilities are subtracted from assets.
The need for book value also arises when it comes to generally accepted accounting principles (GAAP). In accordance with these rules, hard assets (e.g. buildings and equipment) specified in the company’s balance sheet can be specified in accordance with the carrying amount. This sometimes creates problems for companies with assets that are highly appreciated these assets may not be re-evaluated and added to the total cost of the enterprise.
Calculation of book value Bank of America Corporation (BAC)
Presented below is the balance sheet for the fiscal year ending in 2017 according to the annual statements of the Bank 10K.
- Assets amounted to 2,281,234 trillion dollars.
- Liabilities amounted to 2,014,088 trillion dollars.
- The carrying value was $267,146 billion as at the end of 2017.
In theory, if Bank of America liquidated all their assets and money for its obligations, the Bank would be left to pay to shareholders of about 267 billion dollars.
The market value is the value of the company for financial markets. Market value of a company calculated by multiplying current share price by the number of outstanding shares that are traded in the market. Market value also known as market capitalization.
For example, Bank of America over 10 billion shares outstanding (10,207,302,000) as of the end of 2017, and the stock is trading at $29.52 making BofA the market value or market capitalization at 301 billion (10,207,302,000 * 29.52).
As Book Value And Market Value Are Interpreted
When the market value of the company is less than its carrying amount, it may indicate 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 is sufficient future earnings. Value investors can look for a company where the market value is less than its carrying cost, in the hope that the market is wrong in his assessment.
For example, during the great recession, the market value of Bank of America was less than its carrying value. Now that the Bank and the economy recovers, the market value of the company is no longer trading at a discount to its book value.
When market value exceeds book value, the stock market is assigning a higher value due to the earnings power of the company’s assets. Consistently profitable companies that usually have a market value of more than corresponds to their carrying value, since investors were confident in the ability of companies to generate earnings growth and ultimately revenue growth.
When the nook price equal to the market value, the market sees no compelling reason to believe assets of the company is better or worse than indicated in the balance sheet.
The carrying value and market value are two fundamentally different calculations that tell about the company financial stability. Comparison of book value to market value of the company can also help investors determine whether a stock is overvalued or undervalued given its assets, liabilities and its ability to generate income. However, regardless of their financial indicators, it is important to understand the limitations of book value and market value and to use a combination of financial indicators in the analysis of the company.
For more on this topic, including examples, please read the market value vs book value and using the price-book ratio to evaluate companies.