The book value expresses the value of a company "on paper" and is an important fundamental valuation criterion for shares for investors. There is often a significant discrepancy between the book value of a company and its value on the stock market, which can be analyzed using the stock ratio (price-to-book ratio). What the book value is, how it is calculated and what role it plays for stock traders, you will learn in this article.
What is the book value?
The carrying amount of a company is determined by adjusting the assets valued at acquisition and production cost in the balance sheet for depreciation and write-ups.
Simply put, the book value describes the current value of a company's total assets in the balance sheet. For this reason, it is also referred to as balance sheet value or residual value, among other things.
Example:
The purchase of a new car requires 50 000 euros of capital. After one year, the car is still worth 35 000 euros on the market, which corresponds to a depreciation of 30 %. The company records the purchase of the new car for 50 000 euros in the balance sheet and writes off, for example, 20 % of depreciation (i.e. 10 000 EUR).
This means that the reported value of an asset (or a company) does not necessarily have to correspond to the actual value.
The value at which a company is traded on the stock exchange sometimes differs significantly from its book value.
This is how the carrying amount is determined
As described above, the calculation of the carrying amount in a company's balance sheet can be reduced to a relatively simple formula. First, the acquisition or production costs of the assets are used. Then, write-ups are added and depreciation subtracted.
Carrying amount = Acquisition cost/manufacturing cost + Write-ups - Depreciation
Depreciation is usually calculated on a straight-line basis, but this does not always correspond to reality, as the example with the new car has made clear.
Significance of the book value in share trading
Investors and stock traders often calculate the so-called book value per share. The book value is divided by the number of outstanding shares.
The price/book ratio (P/B ratio) can in turn be calculated from the book value per share by dividing the current share price by the book value per share.
Book value vs actual enterprise value
The fact that the book value does not correspond exactly to the value of the company at which it is valued on the stock exchange is the rule rather than the exception. In some cases, there are very significant deviations, which can be measured by a very high or a very low P/B ratio.
Apple, for example, has been valued at five to ten times its book value on the stock market over the last five years. In the case of Deutsche Bank, on the other hand, the exact opposite was the case: the book value was around two to five times the stock market value over the past five years.
Basically, there are two possible interpretations of a very high or a very low book value (in relation to the valuation on the stock exchange):
On the one hand, this can indicate a short-term overvaluation or undervaluation of the market. On the other hand, it can mean that a company has very high growth potential (in the case of a high P/B ratio) or is facing major problems and fears and prices in declines in profits and sales (in the case of a low P/B ratio).