There are many ways an investor can assess the potential of a company before making an investment decision. Two such methods involve calculating the book value and market value of the asset class.
What is Book Value?
Book value shows the company’s value based on its balance sheet. It is based on the accounting “books” of the company, hence the name. The difference between the value of the assets and liabilities is equal to the book value.
What is Market Value?
The market value of an asset is based on its price at a particular time, on the financial market. The market value is arrived at by multiplying the market price of the share by the total number of shares outstanding.
Comparing book value and market value:
When an investor is comparing the book value and market value of a given company, there could be one of three possible scenarios.
In scenario 1, the book value is higher than the market value. When this happens, it usually means that the market doesn’t have confidence in the company’s future performance. This could be due to an unfavourable economy, the company’s operational problems, or even the investor’s lapse in judgment. Value investors prefer to invest in such stocks as they believe that the company will perform better in the future, and the market value of the stock will rise.
In scenario 2, the market value is higher than the book value. Here, the market believes the company’s potential for growth and an increase in its book value. Most companies at the top of the Index, such as Sensex or S&P 500, have a higher market value than book value. Growth investors prefer this scenario. However, it is wise to acknowledge the possibility that the stock is overvalued.
The third and final scenario has the book value and market value as same. In such a situation, the investors believe that the company’s stated assets are more or less as shared in the balance sheet.
Difference between Book Value and Market Value:
An investor needs to understand where the differences between the book value and market value lie so that they can decide which value to consider when investing in a particular stock. Let’s take a look at book value vs market value
1. Book value illustrates the actual value of the company’s assets while the market value informs the investor of the projected value of the company or its assets.
2. The book value reflects the worth of the company’s equity, whereas the market value shows the maximum price at which the company’s share can be traded on the financial market.
3. The book value and market value of the assets also differ in terms of frequency of fluctuation. If we see book value vs market value, the book value is more stable. It changes periodically, usually when the company reports its earnings. The market value, on the other hand, changes quite frequently as the assets are traded through the trading day.
4. The book value indicates the actual cost of asset acquisition, while the market value reflects the market trends.
5. The book value and market value also differ significantly in its use if the company plans to sell an asset. The book value simply shows the accounting value of the asset while the market value accurately reflects the asset’s current popularity in the market.
Keep in mind the function of book value and market value when making an investment decision. It will help you gauge whether the asset is undervalued, overvalued, or realistically valued.
Get in touch with your broker to make the investment of your choice and build your financial stability.