- author: The Finance Storyteller
Understanding the difference between Book Value and Market Value of Stocks in the Stock Market
When investing in the stock market, understanding the difference between book value and market value of a stock is crucial. In this article, we will walk you through the concept and explain book value versus market value using the example of Apple Inc.
Book Value versus Market Value
The value of a stock is essentially one aspect of the return we look for. Book value or accounting value is based on a company's historical financial results, looking backward. It is calculated using the latest financial statements to determine the book value per share. To do so, one needs to find the number of outstanding shares (usually mentioned in the earnings-per-share account in the income statement) and divide that number by the company's total equity.
On the other hand, market value or economic value depends on investor expectations for the future of the company, looking forward. It answers the question, "Do shareholders see blue skies and sunshine ahead, or clouds and thunderstorms?" To form an opinion on a company's future, it is wise to dive into its strategy, technology, and leadership and assess their level of confidence.
The next step is to translate this assessment into numbers. Based on the strategy, technology, and leadership, what do you think the company's revenues, income, and cash flow will be for the next 10 to 20 years?
The final step is to review the probabilities and variations: do you think the expected revenues, income, and cash flow are mostly a "done deal," and therefore risks and volatility are low, or is there a wide range of both positive and negative scenarios, leading to average risk and volatility?
Calculating Book Value of Stocks
To calculate the book value of Apple Inc. stocks, let's look back at their financials. The latest available annual report as of this writing is the annual report as of April 1, 2017.
Apple had assets worth $335 billion, liabilities plus equity worth $335 billion when this video was created. To calculate the book value per share of Apple stocks, take the book value of the company's equity of $134 billion, find the number of outstanding shares, which was 5.3 billion units, and divide the two to get a book value of approximately $25 per share.
When investors make decisions to buy or sell Apple stocks, they look at both book value and market value, and assess the difference between the two to determine if the stock is overvalued or undervalued. This information is crucial for investors to make informed decisions about their investments in the stock market.
Understanding Price-to-Book Ratio in Stock Investing
When investors make the decision to buy or sell a stock, they are always looking towards the future. However, not everyone has the same opinion about the future of a particular stock. In the case of Apple, for example, the stock price in early June 2017 was around $150. Some investors were ready to buy Apple stock at $150, believing that the future was bright and that $150 per share was a good price to buy. Other investors were ready to sell their shares at $150, thinking that the future for Apple was not very promising and $150 per share was a good price to sell.
But what does this price mean? To determine whether a stock is a good buy or sell, we can calculate the price-to-book ratio. This is simply the market value of the stock divided by its book value. In the case of Apple, the market value is $150 per share and the book value is $25 per share, which gives us a price-to-book ratio of 6.
But does this ratio really mean anything? Should you make decisions to buy or sell stocks based on the price-to-book ratio? The answer is yes, and here's why:
High Price-to-Book Ratio
If the price-to-book ratio for a company is high (compared to historical levels, compared to price-to-book ratios of other companies in the industry, or compared to other industries in general), then investors are optimistic about the future of that company. But is this optimism justified? Only time will tell.
Low Price-to-Book Ratio
If the price-to-book ratio for a company is low (compared to historical levels, compared to price-to-book ratios of other companies in the industry, or compared to other industries in general), then investors are pessimistic about the future of that company. But is this pessimism justified? Only time will tell.
Price-to-Book Ratio Below 1
The most interesting situation is when the price-to-book ratio is less than 1. This means that the market price of the stock is trading at less than the book value. This could mean that bad news is on the way, such as upcoming write-downs of assets, unsuccessful mergers and acquisitions, closure of locations due to excessive capacity, or write-offs of uncollectible receivables, which would decrease the book value and return the price-to-book ratio to 1 or higher. It could also mean that some investors have not yet noticed that there is a deal here since they are not trading at book value.
By understanding the price-to-book ratio, investors can make informed decisions about whether to buy or sell a particular stock. However, it's important to keep in mind that the future is uncertain and that a low price-to-book ratio doesn't necessarily mean a bad investment, nor does a high price-to-book ratio necessarily mean a good investment.
The Importance of Understanding Stock Market Terms
Investing in the stock market can be intimidating for new investors, especially when it comes to understanding the terminology and jargon used in the financial industry. However, having a solid understanding of these terms can greatly improve your investment decisions and returns.
Lack of Monitoring and Trading
One factor to consider is that other investors may not have noticed a particular deal, or they may be trading a stock at a price below its actual value. In this case, it is important for investors to discover this deal in order for the price to increase and for the stock's value to return to a fair level.
Reserved Percentage as a Key Criterion
While the reserved percentage may not be the only criterion, it is a key factor that investors should consider when making investment decisions in the stock market. Investors should analyze and weigh all relevant factors before making their investment decisions.
For those who are new to the stock market, there are many informative resources available, including financial expertise YouTube channels that can help explain key financial terms and how to use them. One such channel is "Hukwat Al-Maliya" which provides a wealth of knowledge on money matters to help investors make informed decisions.
Investing in the stock market can be daunting, but having a solid understanding of the terminology and relevant factors can be a valuable asset in making informed investment decisions. To stay up-to-date with the latest financial news and investment strategies, don't forget to subscribe to informative channels like "Hukwat Al-Maliya" and be sure to check out their suggested videos for additional information.