Before making an investment decision, there are many ways that an investor can evaluate the potential of a company. These methods include calculating the market value and the book value of each asset class.
The company's balance sheet is used to calculate its book value. It is calculated using the accounting books of the company. This gives it its name. The book value is the difference between assets and liabilities.
The price of an asset at a given time on the financial markets determines its market value. Multiplying the market price for the share with the number of outstanding shares will give you the market value.
An investor could compare the market and book values of a company to determine which of these three scenarios is most likely.
Simplified 1: The book value is greater than the market value. This is usually a sign that the market has lost confidence in the company’s future performance. This could be caused by a weak economy, operational problems at the company, or even a lapse in judgement. These stocks are preferred by value investors because they believe the company will perform better in future and that the stock's market value will increase.
Scenario 2: The market value is greater than the book value. The market is able to see the potential for growth and increase in the company's book value. The market value of companies that are at the top, such as Sensex and S&P 500 have a higher than their book value. This is what growth investors like. It is important to recognize that the stock may be overvalued.
The final scenario uses the same market and book value. Investors believe that the company's assets are greater or lesser than what is shown on the balance sheet in such a scenario.
Investors need to know the difference between market and book value so they can choose which stock to invest in. Let's look at market value vs book value.
1. The book value reflects the actual value of company assets, while the market value informs investors of the expected value of company assets.
2. The book value represents the equity value of the company, while the market value indicates the maximum price at the which the share can be traded on a financial market.
3. Frequency of fluctuation is another difference between the market value and book value of assets. The book value is generally more stable than the market value. It fluctuates frequently, most often when the company reports earnings. As assets are traded throughout the trading day, the market value changes very frequently.
4. The market value is a reflection of market trends. While the book value represents the actual cost to acquire the asset, the market value shows the market trend.
5. If the company intends to sell assets, both book value and market values will differ. The market value accurately represents the asset's current market popularity.
When making investment decisions, keep in mind both the function of market value and book value. This will allow you to determine if the asset is overvalued or undervalued.
Contact your broker to discuss your investment options and build financial stability.