Book Value vs Market Value of Shares


Welcome to a quick explanation of the difference
between book value and market value of shares on the stock market. I will walk you through the concept, and illustrate
book value versus market value using the example of Apple Inc. The distinction between book value and market
value of a stock is basically one of looking back versus looking forward. Book value, or accounting value, is based
on a company’s historical financial results, looking back. You use a company’s latest balance sheet to
come up with the book value of the equity, you look up the number of shares outstanding
(which is usually mentioned in the earnings per share calculation in the income statement),
and when you divide the two numbers you get the book value per share. Market value, or economic value, depends on
the expectations of investors for the future of the company, looking forward. Do investors see sunshine and blue skies coming
up, or clouds and thunderstorms? In order to form an opinion about a company’s
future, it is wise to dive into its strategy, technology, and leadership. Do these give you confidence that the company
is on the right track? Next step is to try to translate that assessment
to numbers: based on the strategy, technology, and leadership, what do you see as the possible
revenue, income, and cash flow for the company for the next 10 to 20 years? Last step is to review probability and variability:
do you think the projected revenue, income and cash flow are pretty much a “done deal”,
so the risk and volatility are low, or is there a wide range of both positive and negative
scenarios, so the risk and volatility are high? Let’s go from the abstract to the practical
and walk through an example of book value versus market value. To calculate the book value of the shares
of Apple Inc, let’s look back at their financial results. The latest balance sheet that I have available
when making this video, is the balance sheet of April 1st 2017. Apple had assets of $335B, and liabilities
plus equity of $335B. To calculate the book value of one share of Apple stock, you take
the book value of the equity $134B, look up the number of shares outstanding 5.3B units,
and divide the two to get to a book value of approximately $25 per share. When investors make a decision to buy or sell
shares of Apple, they look forward towards the future. It is however very well possible that not
everyone has the same opinion about that future. The share price in early June 2017 is around
$150, this means that some investors are ready to buy the share at $150 as they believe the
future is bright and $150 per share is a good price to buy, and other investors are ready
to sell the share at $150 as they believe the future for Apple is not so bright and
$150 per share is a good price to sell. Now that we have both the book value per share
as well as the market value per share, we can calculate the price-to-book ratio, which
is sometimes called the market-to-book ratio. This is simply the market value divided by
the book value, in the case of Apple $150 per share market value divided by $25 per
share book value, which gets you a price-to-book ratio of 6. Does this number mean anything? Should you take action to buy or sell shares
based on the price to book ratio? If the Price-to-Book Ratio for a company is
high (compared to historical levels, compared to the price-to-book ratio of other companies
in general, or compared to the company’s industry in particular), then investors are optimistic
about a company’s future. Is this optimism justified? Time will tell. If the Price-to-Book Ratio for a company is
low (compared to historical levels, compared to the price-to-book ratio of other companies
in general, or compared to the company’s industry in particular), then investors are pessimistic
about a company’s future. Is this pessimism justified? Time will tell. The most interesting situation is when the
Price-to-Book Ratio is below 1, which means the market price that the stock is trading
at is below the book value. This could mean that bad news is on the way,
for example upcoming write-offs of balance sheet items like goodwill of unsuccessful
acquisitions, closure of sites due to overcapacity, or write-offs of uncollectible receivables,
which would reduce the book value, and return the price-to-book ratio to 1 or higher. It could also mean that other investors have
not spotted that there’s a bargain here, as they are trading a share for a price below
what that share is worth on paper. In that case, the demand from investors spotting
the bargain should drive up the price, and return the price-to-book ratio to 1 or higher. Time will tell! As you can probably judge from my commentary
here, I don’t really use the price-to-book ratio as one of my main criteria in making
stock market investment decisions! Speaking of the stock market, I have a lot
of material available on the Finance Storyteller YouTube channel to explain what key financial
terms mean, and how to use them. I hope this can enable you to make better
investment decisions. Please subscribe to the Finance Storyteller
channel, so you can stay up to date on my latest videos! On this end screen, there are a few suggestions
of videos you can watch next. Thank you.

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