- Common equity book value is not the same as the company's liquidation value. The book value calculation assumes that the company is not at risk of bankruptcy and its shares still trade in financial markets. If the company is bankrupt, liquidators may sell its assets as quickly as possible to pay off creditors, so creditors are likely to receive less than the value that the company reports on its books as sale proceeds.
- Conservative investors can use common equity book value to locate relatively safe companies to invest in. If a company's outstanding stock is worth a total of $20 million, but the company's book value is $40 million, then purchasing a share of stock for $15 gives an investor a claim on $30 worth of assets, without considering any profits that the company earns in the future. Because of this security, these stocks are known as value stocks.
- Book value only refers to the value that the company records for an asset. The current cost to purchase a similar asset could be higher or lower. Accounting methods affect book value. If the company uses inventory replacement costs from several years ago to calculate the cost of goods sold, it will report a higher book value than if it uses current inventory replacement costs to calculate the cost of goods sold. The depreciation method that the company selects also affects the book value it reports, and the company will have a lower book value if it uses accelerated depreciation methods.
- Investors can use the ratio of common equity market value to common equity book value to analyze a company. A rapidly growing company usually has a high ratio, because investors expect the company to become more valuable. A stable company will have a lower ratio, although it is usually still greater than 1. The ratio can become negative if the company has a negative book value because its liabilities are greater than its assets.
previous post