Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Can You Judge a Stock by its Book Value?
Book value is the amount that would be left for common shareholders if all the tangible and intangible assets of a company could be liquidated and all the long- and short-term debt, taxes, and preferred shareholders could be paid. Tangible assets include the physical plant, inventories, and money the company is owed, while intangible assets are the value of patents or brand names. This overall figure is commonly expressed as book value per share, which divides shareholders’ equity by the number of common shares outstanding. Book Value per share is located in the statistical array on the Value Line page. A rising (falling) trend in this number over a period of time indicates that the company is doing a good (poor) job of increasing shareholders’ equity. Investors also compare this number to a company’s stock price to see if a stock is trading above or below its liquidation value. If a company is trading below its liquidation value, investors may have found an undervalued stock. However, it may also reflect a company that is not getting a good return on its assets.
Another method to measure this concept is called price-to-book. To compute this, you take the equity’s current stock price and divide it by its book value. If the number is less (more) than one, the company is selling for less (more) than book value. Thus, a company with good business prospects would be expected to trade above 1.00 because the price-to-book ratio should reflect the value of its growth potential.
There are some pitfalls to this analysis. Management has some discretion in how it accounts for assets on the balance sheet, so certain accounting practices can throw off this figure’s accuracy. For example, the method a company uses to depreciate its assets will affect its book value. As a result, it can be difficult to compare stocks that are even in the same industry if they choose to handle their accounting differently. Also, of note, this number is not as meaningful for businesses that are not capital intensive. Therefore, if you are researching a technology company, book value per share may not be as important as other valuation concepts. All told, investors should be aware of these factors when evaluating stocks with this measure.
In the end, book value should be just one part of your analysis. You cannot truly measure a stock’s worth by book value alone, but it does provide a good basis for analysis.