Introduction to Stock Valuation Part 2 – Book Value and Market Value
Want to spend a bit of time here as this can be confusing for new investors and it is important to understand the difference between book value and market value.
- On the balance sheet we see the value of items at the time they are entered into the accounting system. (Purchased a computer for $1000 – entered it into the accounting systems as a $1000 computer. Its book value is $1000 on the balance sheet). These values get adjusted each year by how much the asset depreciates.
- The value on the balance sheet is called book value and the value someone would pay for that item is called market value.
- Equity is what we want to know to calculate the value of a stock (the market value of equity specifically – we have the book value of equity on the balance sheet).
- You also have heard of the ratio “Price to Book Value”. Since we know the values recorded on the balance sheet are book values, a Price to Book value ratio is the amount we would multiple the book value on the balance sheet by to get a Market value (aka Price).
We see the Dec 31, 2016 Equity Value on the balance sheet in Part 1, is 70418 (in 000 000’s of $). If we divide that equity value by the number of shares outstanding we get the bookvalue per share for the company. ($26.02).
|Book Value of Equity for Johnson & Johnson as Dec 31 2016|
|Equity on Balance Sheet (000’s)||70 418 000|
|Number of Shares Outstanding (000’s)||2 706 511|
|Book Value Per Share||$26.02|
Since companies do not report their financials until weeks (months) after the end of the fiscal period the price to book ratio will use the most recent value we have (ie Dec 31st). We can backtrack to the date of the most recent financials so we are always using the same date to compare over time. For example, on Dec 31, 2016, JNJ’s stock was trading at $112.25. If we divide that price per share by the book value per share we get a Price to Book-value of 4.31. This is at the high end of its PB range for the last 10 Years
|Historic Price to Book Values for Johnson & Johnson 2007-2016|
Is JNJ Expensive on a Price to Book Ratio?
Based on the historic values we would have to conclude Yes.
We see from the high in 2007 of 4.37 (and we could go further back) JNJ’s
book value per share dropped to below 3.00 during 2010-2012 period.
Its stock price has doubled since then with it book value increasing about 50%.
But that is not the whole picture, rather 1 data point in a valuation.
Figure 4. Five year Price performance for JNJ:NYS (Source Yahoo Finance)
Look forward to the next in our investing education blog series of “Introducing Stock Valuations”, where we will be discussing Discount Rates….