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Both book value and market value can be important tools for investors hoping to build strong portfolios. While the market price of each stock provides clues to a company's financial strength and future prospects, book value reveals the current state of the company and ignores future growth potential. Combining these two figures can help you determine whether a stock is valued correctly, which can help you get the most out of your investment.
The book value of a company represents how much a company is worth based strictly on its balance sheet. To find book value, add up everything the company owns in terms of assets, then subtract everything the company owes, such as debts and other liabilities. Book value reveals how much the company is worth if it were liquidated and all assets were sold for cash. By dividing book value by the total number of shares outstanding, you can find book value per share.
Market value per share is a much easier figure to derive. The market value per share is simply the price of each share on the open market or how much it would cost to buy a share of stock at any given point. While book value represents how much the company's assets are worth, market value reveals what investors think the company is worth and how much they will pay to buy stock in the firm.
Investors may use a financial ratio known as the price to book ratio to compare different companies. To find price to book ratio, divide the market price for a share of stock by the book value per share. If price to book ratio equals 1, the book value per share and market value per share are equal. If price to book ratio is greater than 1, the market value is higher than the book value. When price to book ratio is less than 1, the market value is lower than the book value.
Typically, market value per share will be higher than book value per share for a given company. The higher market price reflects the value of intangible assets, such as goodwill, patents, brands or research and development. Market value is also higher than book value for most stocks because investors place value on the future growth and earnings of the company beyond what's reflected on the balance sheet.
Some investors actively seek out stocks that they believe are undervalued. One way to find these stocks is to look for stocks with a price to book ratio of less than 1, or a book value per share that's higher than the market value per share. While these stocks can be tough to find, Investopedia suggests narrowing your search by looking for large, old companies, particularly those involved in non-glamorous, "ugly" industries like coal or oil. These companies don't tend to make headlines like technology stocks and are more likely to be undervalued than more mainstream, exciting firms like electronics makers or food and beverage companies.
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