Investors have many metrics for determining the valuation of a company’s stock, and two of the most commonly used are Book Value and Share Value (also known as Market Value). Both valuations can be helpful in calculating whether a stock is fairly valued. Let’s look briefly at the differences between the two as they can impact the loan-to-value of your LeverageLine line of credit.
So What is Book Value?
The book value of a stock is the amount of cash that would be paid to shareholders if the company was fully sold/liquidated as if it had paid off all of its liabilities. Therefore, the book value equals the difference between a company’s total assets and liabilities. Book value is recorded in the company’s books also as “shareholder equity”; in other words, the book value is literally the value of the company according to its books (its balance sheet) when all liabilities are subtracted from all saleable assets.
The need for book value is also part of compliance with the so-called generally accepted accounting principles (GAAP) regimen which allows for legitimate comparison of company and stock value in comparison with other companies compliant with the same accounting system. According to these rules, hard assets like buildings and equipment can only be stated using this book value system. This can create challenges for companies with assets that have greatly appreciated. That’s because such assets have relatively static value when added to the overall valuation of the company as a whole.
What Is Share Value?
Market value is defined as the value of a company according to the buying and selling activity of the open market. It is calculated by using the formula “current stock price multiplied by the number of shares currently trading on the open markets.
Book Value Vs. Share Value
When Share (Market) value less than Book Value: This is a common scenario when the natural stock market price-per-share is affected by a lack of confidence for any reason. The investors in the market are “voting” by their selling and buying activity. A news article or other development may cause consumers to disbelieve that the book value is accurate. Perhaps there is gathering debt, or a new product is not selling as expected. Some “value investors” might be looking for a company where the market value presents an opportunity for growth as it is undervalued.
Such securities can be excellent for LeverageLine, as the initial LTV will remain the same, the value of the portfolio guaranteeing the line would grow, providing both the benefits of the LeverageLine and the benefits of portfolio growth. Since our LeverageLines have very low interest, it is possible that portfolio share value growth might even wipe out the current or overall cost of financing (interest on whatever has been drawn).
When the market value is greater than the book value: Consistently profitable companies usually have market values greater than their book values because investors have confidence in the companies’ revenue and earnings growth.
When book value equals market value: The market sees no reason to believe the company’s assets are better or worse than what is stated publicly.
Please remember that as with any stock or securities matter, there are limitations in analyzing future performance. They are relatively useful as general measure.