The book value per share (BVPS) ratio compares stockholders’ equity to the total number of outstanding shares. In other words, this calculates a company’s per-share total assets less total liabilities.
Value investors have traditionally embraced book value per share as a method of valuing different investments.
Benjamin Graham, the founder of value investing, developed what is known as a “margin of safety.” In essence, the margin of safety is a discount on the stock price compared to its underlying value.
Graham created a straightforward, yet comprehensive, stock selection model so that investors could determine a business’s underlying worth and choose undervalued stocks with room to expand.
Buffett espoused using book value to value Berkshire for years before the company’s nature changed and how he believed Berkshire would continue to grow. Berkshire continues to buy back shares above book value but below intrinsic value. It helps illustrate how book value represents a snapshot in time, not allowing for future growth or profitability.
In today’s post, we will learn:
- What is Book Value Per Share?
- Understanding Book Value Per Share
- How to Calculate Book Value Per Share
- Calculating Book Value Per Share with Real Companies
Okay, let’s dive in and learn more about book value per share.
What is Book Value per Share?
Book value per share according to Investopedia:
“Book Value per common share is a measure used by owners of common shares in a firm to determine the level of safety associated with each share after all debts are paid accordingly.
Should the company decide to dissolve, the book value per common share indicates the dollar value remaining for common shareholders after all assets are liquidated, and all debtors are paid.”
Breaking it down means that if a company goes out of business, that would be the amount of money a shareholder would get once the company liquidates.
Book value per share is an accounting measure based on historical transactions.
Warren Buffett states the book value of Berkshire Hathaway in every annual Shareholder letter that he writes as a way of keeping score.
Buffett laid out his thoughts on the importance of book value versus intrinsic value in his Berkshire 1993 Letter, emphasis bold mine:
“It is important to understand, however, that the two terms – book value and intrinsic business value – have very different meanings. Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.”
Of course, we use book value per share to help us determine the value of those assets relative to the number of outstanding shares. The value relates to the net asset value if you remember from the post on return on assets.
The higher the return on assets, the better the company.
This formula is also known as book value per common share or book value of equity per share.
- Common share: refers to shares you and I buy on the open market of said company. It does not include warrants, preferred shares, retained earnings, or treasury stock.
- Equity refers to the reported assets minus the reported liabilities of a company. Equity is what the common shareholders own when they invest in a company. We discussed this concept in the owner’s earnings.
Understanding Book Value Per Share
Investors (particularly value investors) frequently use the book value per share to judge whether a share is appropriately valued. If the BVPS is lower than the stock price, the stock may be overpriced because it costs more than the assets it is entitled to. In contrast, when the BVPS exceeds the stock price, an investor can effectively purchase a share of a company’s assets for less than those assets are truly worth.
Like any metric or valuation method, book value per share has limitations.
One drawback of book value per share is it doesn’t provide much information to investors on its own. Investors must compare the BVPS to the stock’s market price to evaluate how it affects them.
The fact BVPS offers a conservative examination of a corporation is another drawback. It only assesses the company’s current financial situation. Estimates of increase are therefore not possible.
Businesses with tangible assets benefit from book value as well. Businesses can include all of their inventory in a warehouse in their book value.
On the other hand, software development firms don’t need expensive industrial machinery to manufacture their goods and don’t have any assets needing to be stored. They don’t have a warehouse full of software code investors can look at to predict future sales, even though they might produce revenues with that program.
How to Calculate Book Value per Share
It is a pretty easy formula to calculate and find the information:
Book Value Per Share (BVPS) = ( Total Equity – Preferred Stock) / Shares Outstanding
Let’s break each variable down a little bit to give us a better idea of what they are so we understand how they fit into our formula.
Total Equity: Total equity refers to the total net assets owned by the shareholders. To find this, we take the Total Assets and Total Liabilities from the balance sheet and subtract them to get our total equity owned by us, the shareholders.
Preferred Stock: This is a little more detailed, and we can discuss this further in another post. But, according to gurufocus.com:
“Preferred Stock is a special equity security that has properties of both equity and debt. It is considered a hybrid instrument. Preferred Stock is senior to common Stock, but is subordinate to bonds regarding claim or rights to their share of the assets of the company. Preferred Stock has priority over common Stock in the payment of dividends, and any payments received when a company liquidates.”
Shares Outstanding: Shares outstanding are shares authorized, issued, and purchased by investors and held by those shareholders. They have voting rights and ownership in the corporation by the shareholder that holds the securities. Shares outstanding can be either fully diluted or basic. The fully diluted shares include securities such as warrants, options, or convertibles.
Consider a business with $25 million in shareholders’ equity, $5 million in preferred Stock, and an average of 5 million shares outstanding. Its book value per share is determined by:
- (Shareholders’ equity – preferred Stock)/Common shares
- ($25 million – $5 million) / 5 million
- $4 book value per share
Shares outstanding, as we will use them, are for shares at the end of the period. We use them to calculate balance sheet-related ratios such as BVPS.
The shares outstanding diluted, or basic, are weighted shares over a period such as a quarter or a year. They are usually used to calculate income or cash flow statement-related items such as earnings per share (EPS).
Calculating Book Value Per Share With Real Companies
To see how easy this is, let’s look at a few companies and balance sheets to learn how to calculate this formula.
Microsoft (MSFT)
Let’s pull some numbers from the balance sheet to start plugging into the formula. All numbers stated will be in millions unless otherwise dictated.
First, we will need the following:
- Total equity equals $166,542 million.
- The preferred stock equals $0.
We will need the next set of data to find the outstanding shares.
Notice on the balance sheet that they have reduced that value from the total shareholders’ equity. We can find the outstanding shares at the bottom of the income statement or the beginning of the 10-K or 10-Q.
The share count that we are using is 7,496.
Now, we will get our result by plugging all the numbers into the formula.
BVPS = ( Total Equity – Preferred Stock / Shares Outstanding
BVPS = ( 166,542 – 0 ) / 7,496
BVPS = 166,542 / 7,496
BVPS = $22.22
Pretty darn easy, huh?
Goldman Sachs (GS)
Total shareholders equity: $109,926 million
Preferred stock: $10,703 million
Shares Outstanding: 350 million
Let’s plug the numbers into our formula and see the results.
BVPS = ( 109,926 – 10,703 ) / ( 350 )
BVPS = 99,223 / 350
BVPS = $283.49
Next, let’s look at another financial institution that you may not have heard much about, although it is one of the country’s largest insurance banks.
Cincinnati Financial (CINF)
CINF offers property and casualty insurance and has over 1% of the domestic property and casualty premiums in the US, which ranks as the 20th largest insurance company in the US by market share.
A fun fact about CINF: they are one of the rarified companies considered a dividend king, which means they have raised their dividends for 56 consecutive years.
Only 18 companies can qualify for Dividend King status, so they are special indeed. And chances are you have never heard of them, and they are certainly not in a sexy business. If you would like to learn more about Cincinnati Financial, follow this link.
Getting back to calculating our book value per share, let’s dive deeper into Cincinnati Financial’s balance sheet.
Total shareholders equity: $13,105 million
Preferred Stock: $0
Shares outstanding: 160.4
Plugging in our numbers, we get this result.
BVPS = ( 13,105 – 0 ) / 160.4
BVPS = 13,105 / 160.4
BVPS = $81.71
Berkshire Hathaway (BRK.B)
Anyone familiar with Warren Buffet and Charlie Munger will recognize the name and the assets within the conglomerate, i.e., Berkshire Energy, BNSF, GEICO, and many more.
We are gathering the numbers for our formula.
- Shareholders equity: $514,930 million
- Preferred Stock: $0
- Shares outstanding: 2,265 million
Plugging all those numbers into our formula.
BVPS = ( 514,930 – 0 ) / 2,265
BVPS = 514,930 / 2,265
BVPS = $227.34
Lockheed Martin (LMT)
I am picking out the numbers from the balance sheet.
- Shareholder’s equity: $10,959
- Preferred Stock: 0
- Shares outstanding: 277 million
Plugging all the numbers into our formula, we get:
BVPS = ( 10,959 – 0 ) / 277
BVPS = 10,959 / 277
BVPS = $39.56
That wraps up our look at the balance sheets of many different companies, spanning a range of industries and sectors.
Final Thoughts
Calculating book value per share is easy, but you are probably wondering why we do this exercise.
It is another brick in the wall to help us value any company. Along with return on equity, return on assets, and return on invested capital, this formula can help us find the real value of a company.
Warren Buffett has said several times that we should value companies consistently, using the same methods, regardless of the business. He thinks the company’s value remains tied to the profits and cash flows it can produce over its lifetime and the returns on the capital it can produce to continue the growth.
These tools that we have looked at are just one more step along that path.
Unfortunately, calculating BVPS does not always reflect the true value of, let’s say, Apple.
Because they carry assets on the balance sheet at the original price minus depreciation, this could lead to underestimating the true economic value of the assets of the company. Along with the economic impact of intangibles and the fact that many companies now finance growth from the income statement instead of the balance sheet.
These changes in how businesses reinvest and how accounting has not kept up impact how we start to value different businesses.
Another benefit of calculating this formula is that it helps calculate another ratio: the price to book value, or the P/B.
Price to book is a favorite of value investors as it gives a good indication of the relation of the company’s book value to its price.
A great way to find undervalued companies is to look at the price to book ratio; anything under one is considered undervalued in correlation to its equity.
As always, remember that finding a great book value per share is not the end all, be all for locating a great company to invest in. These formulas we have been discovering are just building blocks in our search for intrinsic value and a margin of safety.
Thank you for taking the time to read this post; I hope you found some value in it.
Take care,
Dave
