Book value per share (BVPS) is used by investors to determine the value of a company’s stock. If investors find that the stock’s market price is below the BVPS, then the stock is undervalued, and vice versa. As a company’s BVPS increases, its stock price should also increase and become more valuable.
If you’re unfamiliar with investing, it may be difficult to learn how brokerages and individual investors decide which stocks to purchase. Though some of this choice comes from the investor’s personal preferences and investment strategy, investors also decide based on a stock’s book value per share.
Book value per share is a valuable formula for potential investors interested in learning a company’s current stock price. It can show an investor whether a stock price is overvalued or undervalued. But it can be somewhat tricky to understand, especially if you’re new to the world of the stock market.
In this article, we’ll outline what book value per share is used for, what the formula is, as well as some of its setbacks.
What is the book value per share and what is it used for?
Book value per share (BVPS) is a method used to determine the value of a stock. Investors use BVPS to calculate whether a company’s stock market value is overpriced or undervalued. In the event that the company is liquidated, the BVPS will also inform shareholders of the funds they may receive.
Book value is made up of two things: a company’s assets and liabilities. Assets include everything the company owns, such as property, inventory, and cash on hand. Liabilities include debt or taxes owed. To determine a company’s book value, you subtract the number of liabilities from the total assets. These numbers are found on the company’s balance sheet.
In case you aren’t familiar with some of the terms used in this article, let’s quickly look at what “book value” and “share” mean.
- Book value refers to a company’s total equity or net asset value.
- Share refers to the stocks that can be bought and sold.
Why is book value per share important?
One of the main reasons investors use BVPS is to determine whether a company’s stock is overvalued or undervalued. If the stock is overvalued, then the stock’s market price is above its BVPS, and an investor may not receive a great return on their investment.
On the other hand, when the stock’s BVPS is above the market price, the stock is considered “undervalued.” Undervalued stocks may be worthwhile investments for some investors, as they may receive high returns for a low initial cost.
However, BVPS purely focuses on the book value and ignores other factors that could impact a stock’s price. So while BVPS is an important formula that has its use, it isn’t without flaws. When determining the value of a stock, there may be other factors or formulas to consider before using BVPS.
Interested in learning more about investing in the stock market? Check out SuperMoney’s eight basic concepts for investing in the stock market. These tips are great for beginners interested in the stock market but aren’t really sure where to start.
If you’re looking to learn what kind of investment would be best for your portfolio, you may want to speak with an investment advisor as well.
Book value per share formula
There are two steps to calculating a company’s BVPS. The first step is to subtract the preferred equity from the shareholders’ equity, which is often referred to as the book value of equity. The book value of equity is then divided by the average number of common shares.
Here’s what the formula looks like:
When calculating a company’s BVPS, you’ll recognize that only include common stockholders’ equity is included in the formula. Since preferred stockholders are valued more highly and paid before common stockholders, preferred stock is excluded.
Using the BVPS formula
An investor would like to know the value of Business X’s stocks. They will use the BVPS formula to determine this.
The investor looks at Business X’s balance sheet and sees that Business X has $15 million in stockholder’s equity. Of that $15 million in equity, $5 million is preferred stocks. Business X also has an average of 5 million outstanding common shares.
Using the formula mentioned above, the BVPS would equal just $2. Here’s how we would calculate it:
How to increase book value per share
If the BVPS formula shows that the BVPS is higher than the company’s stock price, then that company may want to increase its book value per share. As the BVPS increases, it stands to reason that the stock price should also increase, making the stock more valuable.
Fortunately, there are a couple of ways a company could increase its book value per share.
- Increase assets, reduce liabilities. A company can increase its BVPS by using its earnings to purchase more assets or reduce liabilities. So, if a company has $500,000 in revenue, it can buy more assets to increase its common equity, thus raising the BVPS. Otherwise, the company could use some of that revenue to pay off debts. This will increase available equity and raise the BVPS.
- Purchase stocks. A common method used to increase book value per share is by buying back common stocks from stockholders. Repurchasing common stock is a simple yet effective way to increase BVPS.
Setbacks of book value per share
Unfortunately, BVPS can’t tell investors everything. There are two major setbacks to using BVPS to determine a company’s value. The first is that it does not show growth estimates. The second is that it favors companies that sell physical assets.
While BVPS is a great way to get an idea of what a company’s current financial standing is, it doesn’t show future growth opportunities the company may have. For example, perhaps the company is planning on purchasing more assets or has included paying off debts in the future budget. BVPS will not account for that.
Second, BVPS highly favors companies that sell physical assets. So BVPS may not accurately show the value of a company that does not have stored assets, such as a software company or massage business.
Book value per share and market price share
BVPS is just the first step an investor must take to see how valuable a company’s stock is. Next, they must compare the BVPS to the market price share.
The market value of a company is the current price of a company’s shares. Meanwhile, book value per share reflects a company’s historical costs and does not show the current market value of a company. Because of these differences, investors must analyze both when determining the value of a stock price.
- Book value per share is used by investors to determine the value of a company’s stock.
- The formula for book value per share (BVPS) is (shareholders’ equity – preferred stock/equity) ÷ average number of common shares outstanding = book value per share.
- If a company’s book value is more than its stock price, then the price is undervalued. If a company’s book value is less than its stock price, then it’s overvalued.
- While calculating BVPS is very useful, it could have setbacks for companies that do not sell tangible assets.
Learn important concepts about investing
If you’re new to the world of investing, it can be overwhelming. There’s so much information out there, where do you even start? Well, SuperMoney is here to help.
First, take a look at our beginner’s guide to investing. This can help you understand what investment platforms are available to you and how to get started. These methods are easy to understand and are written for everyone, so it’s the perfect place to start your investment journey.
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Camilla has a background in journalism and business communications. She specializes in writing complex information in understandable ways. She has written on a variety of topics including money, science, personal finance, politics, and more. Her work has been published in the HuffPost, KSL.com, Deseret News, and more.