Book value vs. market value

The market value and book value of a company can help you evaluate the true value of its stocks and the firm’s potential for growth.

What is the difference between book value and market value?

Book value and market value are essentially mathematical equations that help you gauge the true worth of a stock and the financial might of the company behind it.

The market value of a company is the price of a share of its stock multiplied by the number of outstanding shares in the open market. Book value is the difference between a company’s total assets and liabilities. Comparing the two can help you determine whether a stock is undervalued, overvalued or generally priced correctly.

What is book value?

Book value is theoretically what all shareholders would get if a company liquidated all its assets and paid off all its liabilities. This is why book value is calculated as the difference between a company’s total assets and total liabilities. Assets include all the company’s financials, including:

Total liabilities are everything the company needs to pay back. This can include various liabilities such as:

But book value has its limits. For instance, it’s sometimes difficult to measure the value of a company’s intellectual property and other intangibles. You may also need to gather several financial documents to determine the impact of a company that has been depreciating its assets.

Book value formula

You can find the book value of a company by subtracting its total liabilities or what it owes from its total assets. Here’s the formula.

So how do you find a company’s total assets and liabilities? This information is found on a company’s balance sheet, which is typically found in the investor relations section of a company’s website. You can also try looking up “Company ABC balance sheet” followed by the current year on Google.

Let’s calculate the book value of a major company like Microsoft. These values are taken from its Earnings Release FY20 Q3.

• Total listed assets: $285,449 million
• Total liabilities: $170,948 million
• Total assets minus total liabilities: $114,501 million

You can also skip the math as book value is often reported as “shareholder’s equity” or “stockholder’s equity” on a company’s balance sheet.

What is market value?

The market value of a company is the current price of a single share of its stock multiplied by the number of outstanding shares held by all shareholders in the market. This is also known as the company’s market capitalization.

It essentially tells you what investors are willing to pay for a company’s stock based on all publicly available information. It also tells you how much shareholders would get if the firm decides to liquidate the company.

Market value formula

Also called market capitalization, the market value of a company is the price of a single share of stock multiplied by the number of outstanding shares. Here’s the formula.

Let’s revisit Microsoft. The price of a single share of Microsoft stock is $211.01 as of Nov. 10, 2020 when the Nasdaq closed. It currently has roughly 7,560,495,969 outstanding shares. So if you multiply these two figures, Microsoft has a market value of $1.59 trillion.

How to interpret book value and market value

The market value and book value of a company can vary by a large margin. Comparing these two metrics can help you determine whether a stock is overvalued, undervalued or rightly priced in the market.

Book value is greater than market value

If the book value of a company is greater than its market value, it could mean investors aren’t confident about the company’s financial performance or future.

Remember, book value is the value of a company based on its books or balance sheet. Market value depends on what investors are willing to pay for the company’s stock. So if book value is greater than market value, it could mean investors don’t believe the company is worth the price on its books.

But it could also mean the market is wrong in its valuation of a stock, so value investors may seek out these companies in hopes that they can buy the stock and sell it for more than what the market currently values it at.

In other words, they’d be buying stocks at a discount in hopes that it will improve in the future. This scenario might behoove long-term investors, but active day traders may not benefit much from companies that have greater book values than market values.

Market value is greater than book value

In some instances, market value may be higher than book value. In our previous example, we found Microsoft has a much larger market value ($1.59 trillion) than book value ($114,501 million).

This could mean the company’s stock is overvalued, which in turn can mean that investors are confident in the company’s future earnings potential. In such cases, investors would be confident paying more for a stock because they believe the company could boost its financial strength based on its current state and plans for the future. But the downside is that the company’s stock may be selling for more than it’s actually worth.

Book value is equal to market value

If a company’s book value is equal to its market value, it could simply mean that the market is accurate in its valuation of its stocks. And investors are paying for exactly what the stocks are worth.

This could be a good sign for risk-averse investors who just want to buy stocks for what they are worth and aren’t very interested in timing the market. In other words, this situation may appeal to investors who don’t want to gamble on whether a stock is overvalued or undervalued.

Compare brokerage accounts

Market value and book value are two useful metrics that can help you determine the true value of a company’s stock. But before you can buy a single share of a company’s stock, you need to open a brokerage account. Not all are the same, and key differences can affect your returns. So be sure to compare your options.

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Bottom line

Book value and market value can help you gauge a stock’s true value. This can aid in your decision making when buying and trading stocks, and it can guide your investment strategy.

Frequently asked questions

• Should I always invest in companies with high market values?

  Not exactly. Some investors believe a high market value means the company is well equipped for future growth and gains and that people are confident in its performance.

  But it can also mean investors are overconfident and the company is worth more than it actually is. The market value of a company isn’t a perfect measure of a company’s worth. So you should carefully analyze the company’s financials, capacity for growth and other helpful metrics like book value.

• Do bonds have market values?

  Yes. A bond’s market value depends on current interest rates, and it represents the price at which you can sell a bond to another investor before it matures. In other words, it’s the price investors are willing to pay for the bond at any given time.

• Do bonds have book values?

  Not exactly. But there is another metric investors look at called par value. This is the price you paid for a bond when it was issued. It’s the amount of money the issuer promises to pay you back on the maturity date.

  This can differ from market value depending on the interest rate environment and what investors are willing to pay. For example, you may be able to sell a bond for more than you bought it for if its market value goes up before it matures. However, brokers charge a markdown on bonds sold before maturity. This is a commission, typically a percentage, charged against the sales price of the bonds. It’s important to ask about this markdown before choosing to sell early.