Book value per share compares the amount of stockholders' equity to the number of shares outstanding. If the market value per share is lower than the book value per share, then the stock price may be undervalued. Thus, this measure is a possible indicator of the value of a company's stock; it may be factored into a general investigation of what the market price of a share should be, though other factors concerning cash flows, product sales, and so forth should also be considered. The measurement is rarely used internally; instead, it is used by investors who are evaluating the price of a company's stock.
If book value per share is calculated with just common stock in the denominator, then it results in a measure of the amount that a common shareholder would receive upon liquidation of the company.
The formula for book value per share is to subtract preferred stock from stockholders' equity, and divide by the average number of shares outstanding. Be sure to use the average number of shares, since the period-end amount may incorporate a recent stock buyback or issuance, which will skew the results. The formula is as follows:
(Stockholders' Equity - Preferred Stock) ÷ Average shares outstanding
For example, ABC International has $15,000,000 of stockholders' equity, $3,000,000 of preferred stock, and and an average of 2,000,000 shares outstanding during the measurement period. The calculation of its book value per share is:
$15,000,000 Stockholders' equity - $3,000,000 Preferred stock ÷ 2,000,000 Average shares outstanding
= $6.00 Book value per share
Anyone using this measure should be aware of two issues, which are:
- The market value per share is a forward-looking measure of what the investment community believes a company's shares are worth; conversely, the book value per share is an accounting measure that is not forward-looking at all. The two measures are based upon different information. Consequently, it is dangerous to compare the two measures.
- The book value concept tends to undervalue (sometimes to a considerable extent) a number of assets. For example, the value of a brand, which has been built up through many years of marketing expenditures, may be the primary asset of a company, and yet not appear in the book value figure at all. Similarly, the value of in-house research and development activities could be very high, and yet this expenditure is charged straight to expense in most cases. These factors can yield a massive disparity between book value and market value.