When investing in a company, investors must measure the value of their investment. There are several metrics that can help companies to do so. On top of that, for public companies, the values are usually available on the stock market. For investors, both book value and market value can be a reliable measure of a company’s value. However, both of these are fundamentally different.
There are several key differences between book value and market value. However, it is crucial to what each of these is before discussing those differences.
What is Book Value?
Book value is the total value of a company’s equity in its balance sheet. Usually, this information is available on the financial statements. For investors, the value of assets that a company owns also represents its book value. However, they must deduct any liabilities and intangible assets to reach the book value.
When evaluating companies, the book value can be a significant indicator of internal resources. On top of that, it can also provide comparisons with the market value. By doing so, investors can determine whether a company’s stocks are undervalued or overvalued. In essence, book value represents a company’s net asset value.
There are several factors that drive a company’s book value. The first includes the overall assets a company owns. The higher the value of a company’s total assets is, the more its book value will be. However, it will also depend on a company’s liabilities. If companies rack up significant liabilities, their book value will decrease.
How to calculate Book Value?
Calculating a company’s book value is straightforward. As mentioned, book value represents a company’s total equity. Equity represents a company’s share capital and retained earnings. Based on this definition, the formula for book value is as follows.
Book Value = Share Capital + Retained Earnings
However, there are other methods that can help in the calculation as well. As mentioned, some investors also calculate a company’s book value by deducting its liabilities from its total assets. In some cases, they will also subtract the value of intangible assets from the total assets. Based on this definition, the formula for book value is as follows.
Book Value = Total Assets – Total Liabilities
In the above formula, total assets cover all financial, physical and intangible assets. These assets can either be current or non-current. Similarly, liabilities include both current and non-current liabilities.
What is Market Value?
The market value represents a company’s evaluation set by the market. For most businesses, it is the value that investors will pay to acquire it. However, for companies, it is different. A company’s market value depends on its share prices. A market, usually the stock market, sets these prices. On top of that, companies will also have a varying number of shares.
Therefore, for companies, market value is the total market value of a company’s issued shares. The term used to describe this value is market capitalization. Market capitalization refers to the total market value of a company’s outstanding shares of stock. Investors can calculate this metric by multiplying the total number of outstanding shares by their market value.
There are two components that affect a company’s market value. As mentioned, these include the share prices and the number of outstanding shares. Both of these have a positive impact on the market value. Therefore, they must be high for a higher market value. Usually, the number of outstanding shares remains uniform unless companies issue new shares. However, the share prices in the market fluctuate from time to time.
How to calculate Market Value?
The calculation of market value is straightforward. Investors need to obtain a company’s share prices from the market. Once they do so, they must multiply it with the company’s number of outstanding shares. This number is available in the financial statements. The product of both these figures will represent the underlying company’s market value. Based on this definition, the market value formula is as follows.
Market Value = Number of Outstanding Shares x Share Price in the Market
Using the above formula for market value, investors can easily measure a company’s value. Usually, the information required for it is readily available. For private companies, however, this information is challenging to obtain. On top of that, the share prices for these companies will not be accurate as established markets don’t exist for them.
Book Value vs Market Value: What are the key differences?
Book value and market value both provide a good measure of a company’s value. However, both of these show different aspects of that value. On top of that, investors use them for several purposes. Some of the factors that make book value and market value different from each other include the following.
The primary difference between book value and market value is the definition for both metrics. As mentioned, book value represents a company’s net asset value. In other words, it is the value of a company’s total equity. Market value, in contrast, is the value of a company provided by the market. This value does not depend on a company’s assets or liabilities.
The components used to evaluate a company’s book value and market value are also different. Book value depends on two factors, a company’s total assets and total liabilities. Of these, assets must be high and liabilities low to achieve a higher book value. Market value, in contrast, depends on share prices and the number of outstanding shares. Both of these must be high for a higher market value.
Book value usually comes from the company’s operations. Its primary source includes the balance sheet where a company’s total assets and liabilities are. On the other hand, the primary source for market value is the market. The market determines a company’s share prices. However, it also gets the number of outstanding shares from the financial statements.
As mentioned, book value primarily represents a company’s equity or net asset value. Therefore, it shows how much a company is worth based on its total asset and total liabilities. However, market value shows a company’s current market price. It illustrates how much the market values the company based on various factors.
A company’s book value remains the same for a longer time. Usually, it changes from one period to another. When companies prepare their financial statements, they will also the latest book value. On the other hand, a company’s market value fluctuates more often. These fluctuations occur due to market forces that dictate a company’s share price in the market.
Due to several factors, one of which includes fluctuations, the accuracy of both figures also differs. A company’s book value usually stays accurate for a long time unless significant changes occur in its assets or liabilities. However, the market value depends on the market’s perception. Therefore, this figure will not often be an accurate representation of a company’s value.
The accuracy of both figures will also depend on manipulation. Usually, a company’s book value is more susceptible to manipulation. The primary reason for the susceptibility is the control a company has on determining its book value. On the other hand, the market value is less susceptible to manipulation. However, it is not totally free of it.
Book value and market value are two metrics that investors use to evaluate a company. Book value represents a company’s total equity reported in its financial statements. In contrast, the market value represents a company’s value based on market perception. These metrics are different due to their definition, components, sources, meaning, fluctuations, accuracy, and manipulation.