Book value per share known as BVPS, is calculated by dividing the equity available to common stockholders by the number of shares outstanding. The book value per share can also been used to determine the stock’s current value. It is a comparison with the current market price per share. The company’s stock will be deemed undervalued if the BVPS value exceeds the current market value per share.
The book value can be used as an indicator of the stock’s value and used to predict the market price for a share in the future.
Mainly book value per share (BVPS), is a ratio that compares stockholders total equity to the number of outstanding shares. This is a measure of a company’s total assets minus its total liabilities on a per share basis.
One way to gauge the stock’s value is by looking at its book value per share. It is helpful to break down each aspect in order to better understand the book value per share.
As per book value per share of a company is calculated using the equity of common stockholders. Prefer stock should not be included in the equity calculation. This is because preferred stockholders rank higher than common stockholders in liquidation. The BVPS is the equity value left after all debts have been paid.
Here is the formula to calculate the book value per share:
Formula for Book Value Per Share
N.B. The period-end mainly amount, which includes bascially short-term events, may give incorrect results. Investors may be also misled into believing that the stock price has fallen or is too high.
An Example of a Practical Example
ABC Limited holds $20 million in stockholder equity. $5 million of these preferred stocks are included. During the period, there were an the average of 3,000,000 shares outstanding. Using this information, the BVPS can be calculated as follows:
BVPS = ($40,000,000 – $10,000,000)/ 6,000,000
BVPS = $30,000,000/6,000,000
BVPS = $5
To increase its share price, a company can use these two methods:
1. Common stocks can be repurchased
Common stock repurchases from shareholders are one of the best ways to increase the book value per share. Assume that the company buys back 500,000 common stock shares from its shareholders. The current share outstanding will be reduced to 2.5 million (3,000,000-3,000,000) – 500,000 This is the revised BVPS:
BVPS = $15,000,000/ 2,500,000
BVPS = $6
The BVPS is increased by purchasing 500,000 common stock from shareholders of the company, from $5 to $6.
2. Reduce liabilities and increase assets
The book value per share can be increased by using the profits generated to purchase more assets or reduce debts. If ABC Limited earns $1 million and spends $300,000.00 to buy more assets, it will increase its common equity and raise the BVPS.
Similar to the above, if $200,000 of the revenues is used to pay down debts or reduce liabilities, it will also increase equity available for common stockholders.
How can you increase the book value per share?
Profitable reinvestments are a great way to raise the book value per share of a company’s equity (BVPS).
The accumulation of earnings can be used to reduce liability, which in turn results in a higher equity book value (and BVPS).
Another way to increase the BVPS would be through share repurchases, i.e. Buybacks from existing shareholders.
Market Value Per Share vs. Value Per Share
To evaluate the stock’s value, you can use the book value per share or the market value per share. Market value per share is mainly current price of shares and the price investors will pay for common stock. Market value is forward-looking. It considers the company’s future earning potential. The market value per share will increase as the company’s profitability and growth is predicted to continue.
Book value per share on other hand is an accounting-based tool and is calculated using historical expenses. This metric, unlike the market value per share is not forward-looking and does not reflect the actual market price of shares.
Investors can use the BVPS to determine the true value of a company’s stock. This conservative method involves calculating the stockholders’ share after the liquidation and payment of all debts. When future earnings and growth projections are not as stable, value investors prefer the BVPS to gauge a stock’s potential worth.
Drawbacks to Book Value Per Share
Book value per share is not a valid valuation method. It is based only on the book value and excludes any other material factors that could affect the share price. Intangible factors, such as the value of a company’s shares, are not included in the calculation of the BVPS.
To show how common stockholders would be affected if the company were to liquidate and its debts paid, the BVPS only takes into account the book value of assets (total assets less than intangible assets). This means that tech companies with very few tangible assets may be undervalued, as the BVPS does not include the value of intangible assets.
Limitations on Book Value Per Share
The book value per share has one limitation. It doesn’t tell investors much. To understand how the BVPS affects investors, they must compare it to the stock’s market price.
A limitation of BVPS is that it is a conservative analysis. It only measures the current financial position of the company. This doesn’t allow growth estimates.
Businesses with physical assets also benefit from book value. Businesses that keep inventory in a warehouse count that inventory towards their book value. Tech companies that create software don’t need expensive industrial equipment and don’t have any assets. Although they may be able to generate sales using their software, there isn’t any warehouse that contains software code that investors could look at in order to predict future sales.
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