Book Value Per Share

Book value per share represents the per share amount for the common stockholders that would result if the company were to be liquidated at the amounts that are reported on the company’s balance sheet. If assets could be liquidated at their book value and used to pay off liabilities, also at book value, the excess left—equity—would go to the common shareholders.

Book value per share can be used, possibly with adjustments, to assess merger terms. It is also a very important ratio for analysis of companies with mainly liquid assets and liabilities, such as financial institutions.

Book value per share is common stockholders’ equity (total stockholders’ equity less preferred equity) divided by the number of common shares outstanding.

The number of common shares outstanding used in the denominator should be the number of shares outstanding at the balance sheet date. It should not be a weighted average number of common shares outstanding. The numerator of the ratio is a balance as of a particular date (not an income figure), so the denominator of the ratio should be the number of common shares outstanding as of the same date.

Book value per share has limitations as a valuation tool, however, because it is affected by valuation measures that are based on Generally Accepted Accounting Principles. As such, it has the same limitations that financial statements in general have, as follows.

Limitations of Book Value per Share

• GAAP’s definition of what constitutes an asset or a liability may not coincide with economic reality.
• Long-lived assets like property, plant, and equipment are usually recorded at historical cost less depreciation rather than current market value.
• Book values of fixed assets are also affected by accumulated depreciation, which is subject to estimations of useful life and choice of depreciation methods.
• Intangible assets such as goodwill may be of uncertain value. Likewise, intangible assets that have great value may not be reflected on the balance sheet at all or in book value.
• The assets and corresponding liabilities for off-balance sheet activities are not included.

Thus, a firm’s book value does not equal its market value and its book value per share does not equal its market value per share, nor does the book value equal the fair value of the firm’s net assets. Book value, or the equity on the balance sheet, is merely the accumulation of accounting entries and adjustments that have been recorded during the company’s lifetime. It includes:

• The original capital that was used to start the company
• Proceeds from additional shares issued, minus the cost of shares repurchased (treasury stock)
• Retained earnings (profits minus dividends paid) accumulated over the life of the firm; and
• Activity recorded directly in equity as accumulated other comprehensive income.

Because of the limitations discussed above, if book value is used to compare the relative values of two companies engaged in merger negotiations, adjustments are often made, as follows:

• Carrying values of assets and liabilities, including property, plant and equipment, are adjusted to market values if market values can be determined.
• Differences between the potential merger candidates in the way accounting principles are applied are adjusted for.
• Unrecorded intangibles are recognized.
• Off-balance sheet financing such as short-term leases not recognized on the balance sheet are recognized in assets (the right to use the asset) and in liabilities (the lease liability).
• Intangible assets such as goodwill are eliminated.
• If preferred stock has characteristics of debt, it may be capitalized as debt at the current market interest rate (and removed from the equity section of the balance sheet).