Blog #24 : How Face Value, Book Value and Market Value Differs From Each Other?

Whenever someone enters in share markets, there are lots of things that can make them confuse and there are lot of terms in share market but in this blog we shall see about Face Value, Market Value and Book Value and how these values are calculated, how these values are differ from each other, what is P/B ratio i.e. Price – Book ratio and how P/B ratio can favor you to estimate the fair value of a stock. 

 

Equity Capital &. Face Value

Let take an example of company, say the company manufactures cars i.e. an automobile company. In the process to set up a new industry you have to register a private limited company, appoint the directors and put some initial capital, it is invested by the promoters of the company and this initial invested capital is called equity capital. In exchange of equity capital shares of that company is issued to promoters and these issued shares have a value called Face Value of the share. In simple language Face value is the original value of shares shown in share certificate. Equity capital is calculates as Face Value multiplied by number of shares. Also, Equity capital is the legal capital that must be maintained in the business, it is just like reserve and the capital should not go below equity capital. Funds over and above the equity capital can be distributed to the investors in the form of dividends. The face value of share doesn’t change with time unless stock is split. If you are investing then you should not bother about face value. But Book Value should be considered.

 

Book Value

Book Value is accounting value of shareholder’s equity means the value of shareholder’s equity according to the balance sheet. Let back to our business of car manufacturing company, say the total value of the assets (machineries, real state, and building cost) of the company is 20 units. Further if we divide 20 units say 15 units in equity i.e. promoters capital and remaining 5 units in loan (we shall call it liability) i.e. 20 units is split in 15 units of promoters plus 5 units of liability. Now the value of shareholder’s equity according to accounting will be the Book Value of company. But we have to calculate Book Value per share. The Book Value per share is given by difference of Tangible assets and liabilities divided by numbers of outstanding shares. i.e.

(TANGIBLE ASSETS – LIABILITIES)/NO. OF OUTSTANDING SHARES

As per our example Book Value will be (20 units – 5 units)/1000000 (say no. of shares are 1000000) i.e. 150 units. Consider only tangible assets while calculating Book Value. Let move to market value of a share..

 

Market Value

Market Value is the current trading price of the stock is called Market Value of the share. It is estimated by demand and supply of the share means market is calculating its value according to the future aspects of the company. Say the Market value of the share is 200 units. Pay attention here. See the book value of the share is 150 units as calculated above but according to market its value is 200 units i.e. shareholders are ready to pay the difference. This difference is called premium.

 

 

 

Let see the comparison.

Book value is based on the balance sheet of the company and it is the residual value that remains if the company has to sell all assets. Market value is the market perception about the future of the company and the future of the company depends on the intangible assets (Brand, Technology, copyrights etc.), strategy, leadership, future prospect etc. and based on the performance of mentioned factors people pays premium to buy shares of the company. Here P/B ratio comes into plays i.e. ratio that compare book value and market value. P/B ratio is calculated as Price per share divided by book value per share or market value divided by book value. Let take a deep look.

Companies like oil, manufacturing or heavy engineering companies have high book value due to tangible assets and due to high book value P/B ratio lowers for these industries on the other hands for the asset light industries i.e. technology companies, P/B ratio is higher because the book value get lower for these companies. Technology and their employees are the assets of the company. So whenever you compare two companies, compare for same sector means sector should be same and in this comparison historical P/B is desired to be compared to estimate right value of stock.

 

Follow us @ Facebook: Finance With Atul