When a person wants to invest in share markets, the first logical step before any investment is to know the basics of the market as well as the investment instrument. This basic information and understanding are essential for investors to make sound investment decisions and to ensure that they do not incur any losses on account of lack of information or misinformation.
These basics also include the various modes of valuation of shares. When we value an investment in shares we directly value it according to its current market price. However, not many know that the same current market price will not be reflected in the books of accounts. This basic difference in the valuation of shares has to be understood to correctly value the investment portfolio and know the exact returns on investment.
Given below is the basic meaning of the two most common modes of valuation of shares and the key differences between the two.
Book value of shares is a very common accounting term that is used to denote the value of the shares that are reflected in the balance sheet of the company. The book value of shares is also known as the net asset value or the carrying cost of the shares. The basic meaning of book value of shares is the value that will be received by the shareholders in case the company has to be liquidated.
As per the Indian Accounting Standards, the book value of shares is to be recorded at the historical cost of the shares. This cost is determined after deducting the total liabilities and intangible assets of the company from the total assets of the company. The resultant amount has to be divided by the total number of outstanding common shares to derive the book value per share. This amount is expected to be received by the shareholders upon winding up of the company.
The market value of the shares is the current market price of the shares or the value at which the shares are traded in the market. It represents the market capitalization of the shares which is the value derived by multiplying the current price of the shares with the total number of outstanding shares in the market. The market price of the shares is very fluid and is determined on the basis of the demand-supply function of the market. The other factors influencing the market value of the shares are the financials of the company, profitability, internal and external news affecting the company and the sector as a whole, etc.
Calculating book value & formula for book value
Book value is a measure of a company’s total value that is calculated by subtracting its liabilities from its assets. It represents the amount that shareholders would receive if a company were to liquidate its assets and pay off all its debts. To calculate the book value of a company, you need to add up all its assets, including cash, property, and equipment, and then subtract all its liabilities, such as debts and accounts payable.
The formula for calculating book value is as follows:
Book Value = Total Assets – Total Liabilities
Book value is an important metric used by investors to evaluate the worth of a company’s assets. It provides a baseline valuation for a company’s shares and can be used to determine whether a stock is overvalued or undervalued. Investors can use the book value to calculate the price-to-book ratio, which compares the market value of a company’s shares to its book value. A price-to-book ratio of less than 1 indicates that a company’s shares may be undervalued, while a ratio of more than 1 may suggest that its shares are overvalued.
The valuation of shares is done based on many parameters like the book value of shares, the market value of shares, the intrinsic value of shares, etc. The key advantages of determining the valuation of shares based on the two most common parameters namely, the book value of shares and market value of shares is mentioned below.
- Book value of shares
The key advantages of knowing the book value of shares are
- The book value of shares is the value mentioned in the balance sheet of the company
- This value is the first point of reference for the shareholders and the investors regarding the value of shares and their investment in the company
- The book value of shares is not highly fluctuating as compared to the market value of shares.
- Market value of shares
The key advantages of knowing the market value of shares are
- Market value is a determination of the current market price of the shares.
- A comparison of the market value of shares and the intrinsic value of shares helps in determining if the shares are undervalued or overvalued.
After understanding the basic meaning of the book value of shares and the market value of shares, let us now discuss the basic differences between the two.
| Category | Book value of shares | Market value of shares |
| Meaning | The book value of shares is the value that is accounted for in the financial statements of the company and reviewed by the shareholders and the investors. | The market value of shares is the value of market capitalization of shares. |
| Presence in books of accounts | The book value of shares is reflected in the balance sheet of the company | Market value is not reflected in any financial statements |
| Stability of valuation | Book value of shares does not fluctuate too often unless there is a major change in the value oo the total assets or total liabilities of the company | Market value of shares is constantly fluctuating based on the changes in the current price of the shares |
| Basis of the valuation | Book value of shares is calculated by reducing the value of total liabilities and total intangible assets from the total assets of the company. | Market value of shares is calculated by multiplying the current price of the shares and the total outstanding number of shares in the market. |
| Target users | Book value of shares is reviewed and analyzed by shareholders and potential investors of the company | Market value of shares is reviewed and analyzed by retail investors and traders in the market. |
| Investment approach | Book value of shares is used to calculate with a long-term approach or the long-term investment horizon in a company. | Market value of shares is usually calculated with a short-term investment horizon in a company. |
Conclusion
Book value of shares and market value of shares are two independent concepts that are used to determine the valuation of shares. These details are necessary for the correct valuation of the company and to understand the value of investment for the investors. While the market value of shares changes rapidly based on market fluctuations, the book value of shares is more of a long-term approach to analyzing a company and its relative standing in the sector or the industry as a whole.
FAQs
No. The book value of shares is not readily available and has to be calculated using the balance sheet figures of the total assets, liabilities, and intangible assets of the company.
The basic difference between the book value of shares and the market value of shares is that the book value will help in determining the amount received by shareholders upon liquidation of the company and the market value of the shares is the price at which the shares are bought and sold on the stock exchange.
