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- Book value and market value are ways to evaluate a company. Book value is based on its balance sheet; market value is the total value of shares.
- If book value is higher than market value, it suggests an undervalued stock. If the book value is lower, it can mean an overvalued stock.
- Book value and market value are best used in tandem when making investment decisions.
Among the many measures that investors can use to evaluate companies, two tools are especially popular: book value and market value.
Aside from the word "value" in their names, though, the pair have little in common.
One is an objective approach that encompasses balance sheets and financial statements — a company's books. The other is a more subjective approach, which takes into account the sometimes irrational sentiments of the stock market.
Despite these differences, or because of them, investors often set a company's book value and market value against each other to determine if the shares are overpriced or underpriced — and so whether the stock's a good deal or not.
Let's compare the two metrics more closely.
What is book value?
A company's book value can be determined by subtracting its liabilities from its assets.
The formula is this: Book Value = Total Assets - Total Liabilities
Calculated from a company's balance sheet, book value takes all the company's assets — physical things of value, from inventory and investments to equipment and real estate. It then subtracts liabilities (like loans, taxes, and other debts).
Let's say a company had total assets of $20 million and liabilities of $8 million. The book value of the company would be $12 million: $20 million - $8 million.
Book value is best used with companies that have significant physical assets, such as manufacturers that own factories and plants, heavy machinery, and other equipment. It doesn't work as accurately for companies whose assets are primarily intangible assets, such as information technology or digital firms, whose assets lie primarily in intellectual property — their formulas, systems, algorithms, etc.
Book value alone is just a reflection of a company's equity – what it owns. To be used as a decision-making tool, it needs to be compared to a company's market value before an investor can determine whether to buy or sell a stock.
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Significance
A company's book value is important because it tells you the theoretical amount that shareholders would receive if a company decided to liquidate its assets and settle all its liabilities. A company's book value is considered an accurate depiction of what it is worth.
Further, a company's book value is calculated using its historical data, in other words how much its assets and liabilities were worth at different points.
What is market value?
Definition
Market value, also known as market capitalization, is the total value of a company's stock in the marketplace. It's what it would cost you if you were to buy up every one of its outstanding shares at the current share price.
Investors can benefit significantly from knowing how to calculate market value.
Calculation
This metric can be determined by multiplying the share price by the total number of shares that are trading.
For example, if the current stock price of Company ABC is $105 and the company has 80 million shares outstanding, its market value is $8.4 billion: $105 x 80 million.
Significance
Stock prices are based on expectations of future profitability, and market value is based on these same prospects. As a result, a company's market value is largely a reflection of investor sentiment, more specifically how investors feel about that particular business.
Market value can be a volatile figure. It changes throughout the day because a company's share price constantly fluctuates, as investors and traders buy and sell the stock.
For the most part, though, the number doesn't change very drastically; it only happens if there is significant good news or bad news related to the company or to the industry in which it operates. Total shares outstanding almost never changes, only on rare occasions when company's enact stock buybacks or issue more shares of stock.
Since market value is based on investor expectations, it is a forward-looking way to quantify the value of a company.
Key differences between book value and market value
Basis of calculation
Book value is based on historical accounting data. Market value, however, is based on expectations of future profitability and the market sentiment of investors.
Factors influencing value
Book value accounts for hard financial figures — actual assets and liabilities. Market value is the valuation of a company based on its share price. Yes, that's a number, but it's a figure that fluctuates based on investor perceptions of the company, including such intangibles as proprietary software, artificial intelligence algorithms, and future growth prospects. It is a way of sizing up a company by the value that investors put on it.
Stability
Book value may be relatively stable, since it's based on historical data. Market value, however, may fluctuate quite a bit more, since it depends on the sentiment of investors.
How investors use book value and market value
Book value
Investors can use book value to determine a company's net asset value per share (book value per share). They can use this information to get a better sense of whether a particular stock is undervalued or overvalued.
Figures can be manipulated, and value is to some extent in the eye of the beholder. Still, assuming everything is accurately reported, book value is an insightful number that can be an indicator of its financial health.
Market value
By using this metric, you can figure out what the market thinks a particular company is worth. This can give you some insight into the mindset of investors, meaning how highly they value a company and its future earnings prospects.
Limitations of book value and market value
Book value
Book value has its shortcomings. One of the drawbacks of book value is that it can only be determined from a company's financial statements. As companies usually only report financial statements quarterly or annually, book value is not a readily available number and it is, therefore, a number that can change from one reporting period to the next without any insight into the interim period.
Book value can be difficult to ascertain unless an investor makes an effort to understand how a company's accounting practices work: the type of depreciation used on assets, any claims on assets, and how creditors might sell them in liquidation. Book valuation can be subject to various accounting practices and tax law that can result in it being an adjustable figure.
In contrast, market value is pretty transparent and easy to find — market cap figures for companies are typically a part of online stock listings and corporate profiles.
Another consideration is that the book value of a company may not reflect its true value, as assets are recorded at historical cost.
Market value
The market value of a company is one based on perception and is, therefore, not necessarily an accurate representation of its value. A company's stock price may be inflated or deflated for a variety of reasons, such as the announcement of an acquisition, a new product, or a lawsuit, without any real understanding of the true impact or ramifications of these events.
The history of finance is strewn with companies and sectors, like dotcom stocks in 2000, that inflate in speculative bubbles based on news and rumors, only to come crashing down when investors realize their market value did not equate to their actual financial standing.
Book value vs. market value FAQs
Should I invest in a company with a high market value?
Not necessarily. Having a high market value doesn't always mean a company's shares represent a good investment. It is important to evaluate other measures of a company's financial health, as well as its growth prospects and the relevant competition.
What does it mean if a company's market value is lower than its book value?
If a company's market value is lower than its book value, it could mean that the company's share prices are undervalued, but it is important to investigate any situation further to get a better sense of why a company's market value falls short of its book value.
Which is more important for investors, book value or market value?
Both book value and market value are important for different reasons. Book value gives you a better sense of a company's health, while market value reflects investor sentiment and future growth potential.
Ali Hussain
Ali Hussain worked in credit risk management, analyzing the risk factors of doing business with hedge funds. He started his career with Deutsche Bank and worked at other large financial institutions, such as Citigroup, Bear Stearns, and Societe Generale. After a few years spent in risk management, Ali moved to the front office where he worked in Sales & Trading, covering the sales aspect of the futures clearing business. Ali completed his master's degree in journalism from Columbia University, writing on a variety of topics at school and then embarking on a freelance career upon completion of his degree. In addition to Insider, Ali has written for various publications, including the Huffington Post and Narratively.
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