Updated July 2019
Book value is also known as equity, shareholders’ funds, or net asset value (NAV). It is the value of all of a company’s assets, less all of its liabilities (debts). Book value is sometimes used as an estimate of what a company would be worth if all of its assets were sold for their balance-sheet values. If you know the book value, you can get an idea of how cheap or expensive a share is by dividing the share price by the book value per share (hence the price/book, or p/b, ratio).
A p/b of below one means that – technically speaking – you can buy the company for less than its assets are worth on paper. So if you could buy the whole company, you could sell all of its assets, and still profit. One problem, however, is that the book value may not reflect what you would actually get for those assets. For example, there may be a lot of “intangible assets”, such as goodwill (often relating to the value of a brand).
The value of intangible assets – unlike a factory or a piece of land – can be hard to measure objectively. They may in fact not be worth very much at all – particularly not in a fire sale. So an unusually low p/b could signal a company in trouble, rather than a potential bargain. By subtracting intangibles from book value you get a more conservative number, known as “tangible” book value, based on hard assets, such as land, stocks and cash. If you can buy a stock for a lot less than this figure, it may be a bargain.
Yet note that, as a paper from US money manager O’Shaughnessy Asset Management (OSAM) points out, intangible assets – such as research and development spending – are key parts of today’s companies, and they can often be undervalued too. OSAM found that from 1993 to 2017 stocks that looked expensive on a p/b basis, but cheap on other measures, tended to beat the wider market. In other words, as with any other measure, don’t rely on p/b alone, and understand its limitations.
• See Tim Bennett’s video tutorial: Beginner’s guide to investing: the price-to-book ratio.