In this article, I take a closer look at the book value of the company and why you should consider it when picking your investments. The book value, also called net book value, or net asset value, is the total value of the company’s assets that the shareholders would theoretically receive if a company were to be liquidated. In other words, the net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.
The Book Value
So, the book value is a pretty important factor when considering and evaluating companies, and for this reason, I use it extensively when I publish my dividend stock analysis of a company. It is so important in fact, that it forms the basis of the Graham Number (more on this below), which is a calculation of the fair value of a company as per Benjamin Graham – the father of value investing.
Ben Graham gave us a formula to calculate a Graham Number that is a simple calculation to find the fair price of a company based on the earnings per share (EPS) over the last twelve months and the Book Value (BV). Graham Number is calculated as √(22.5 * EPS * BV).The 22.5 is included in the number to account for Graham’s belief that the price-to-earnings ratio should not be over 15 and the price-to-book ratio should not be over 1.5 (15 x 1.5 = 22.5). Some folks seem to disagree with this approach, but it has served well for most value investors in history.
In today’s frothy market environment, with companies announcing more buybacks than ever before, the EPS numbers get skewed, as some companies resort to financial engineering. How does that work? Earnings per share is one of the most important factors when it comes to investing – and by reducing the number of shares (the denominator), the EPS number is lifted. Buybacks can be good or bad – and there are more bad ones in the current market environment than some people like to admit. I shared this post a few months ago detailing why I think buybacks are an annoyance. If a company is simply taking on debt to finance the buyback, the EPS number does look better, but the overall health of the company may not necessarily be great. Mind you, there are exceptions even to this, where companies like Apple Inc are healthier than ever and still taking on debt to take advantage of the low yield environment – this is one example of a company that I think has been very smart about debt issuance and using the buyback program to its advantage. Getting back to the issue of evaluating companies, this is where book value helps investors – the book value shows actual net asset value of the company taking the liabilities (any debt raised) into consideration.
A short hand used in the valuation is also the Price-to-Book ratio. More details on how to use the P/B here, from Investopedia.
Here is an overview of all my holdings and their Book Value per share, and the P/B ratios.
Do you use the book value of a company during your evaluation? Share your thoughts below.
Full Disclosure: Long all companies mentioned here. My full list of holdings is available here.