Is there any relationship between the market value and the book value of a company? Let’s look at how the two values are related to each other and how investors can use that relationship to make smarter investment decisions.
Book value is also known as the equity of a company. It can be calculated from the balance sheet of a company by finding the difference between its total assets and total liabilities.
For example, the telecommunications operator Starhub (SGX: CC3) had total assets and total liabilities of S$1.809 billion and S$1.765 billion respectively on its balance sheet according to its 2012 annual report. By computing the difference between its total assets and total liabilities, Starhub will have a book value of S$44 million.
In simple accounting speak, it would mean that Starhub would theoretically have a residual value of S$44 million after liquidating all its assets and paying down all its creditors.
Market value on the other hand, is the value that the stock market places on a company. It’s calculated by taking the product of a company’s shares outstanding and its current market price. It’s therefore not surprising to see the market value of a company fluctuate every day as share prices move almost daily.
Going back to our example of Starhub, it closed yesterday at S$4.17 per share and it has a total of 1,721 million shares outstanding. That will give Starhub a market value of roughly S$7.18 billion.
Metric that links them together
The main metric that links the two values together is the Price to Book ratio (P/B ratio). By dividing the share price over the book value per share of a company, we will be able to get the P/B ratio.
If a company has a ratio of 1.0, it means that the market believes that the accounting value of the company is a good representation of its actual prospects. However, for companies with a P/B ratio above 1.0, the market is indicating that it believes the earnings potential of the company is far greater than what is stated in its book value. Inversely, for companies with P/B of below 1.0, the market is viewing the company in a more negative light.
At this point, it is worth noting the huge difference between the market value and book value of Starhub. It shows that sometimes, as with Starhub’s case, there can be no real connection between the two values.
It is worth investigating how the market value and the book value can relate to each other for companies in different sectors. You may be surprised to find that some companies have a market value much closer to its book value, like banks, while others might have a tenuous relationship at best, like Starhub.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.