A company’s market value and its book value typically do not match. Think in terms of antiques: The market value represents how much antiques enthusiasts will pay for a certain piece, while the book value represents the physical value of the antique. Typically, market value exceeds book value, but occasionally investors find a bargain where the stock trades lower than its book value.
The market value of a stock represents the price investors will pay to buy or sell the security. Market value does not always represent the actual value of the company. The terms "overvalued" and "undervalued" compare the market value of a company’s stock to the company’s actual value, or book value.
When a company’s stock sells for more than the company’s book value per share, analysts consider the stock overvalued. Analysts consider stock that sells for less than the company’s book value per share undervalued. For example, a company’s stock might trade at $17 per share, but the company has a book value per share of $15. Analysts would consider this stock overvalued because the market pays more per share than the company is worth.
If a company went belly-up and sold all of its assets and subtracted any liabilities, the remaining value investors would receive represents the company’s book value. In other words, the book value represents the total value of all the assets minus any liabilities. This value often gets referred to as shareholders’ equity or owners’ equity. Book value really ties into how accountants value the company on a per-share basis and has nothing to do with how the market values the company’s stock.
The Real World
Because the market value of a stock is driven by supply and demand, many companies trade well above or often below their book value. Google Inc. is a good example of market value vs. book value. As of the close of the market on Dec. 3, 2010, Google’s book value per share stood at $135.38, but at the final bell, the company’s stock closed at $573 per share. The company’s market value trades well above its book value, but investors willingly purchase the stock at the inflated price.
Although comparing a company’s book value to its market value can help you determine whether a stock is overvalued or undervalued, it’s not the only factor to consider. Often a stock can trade for less than its book value, but that doesn’t mean the company is undervalued. For example, a company that has limited future growth or that operates in a shrinking market can trade below its book value because opportunities for future revenue seem reduced. In this case, the company's market value reflects its uncertain future.
From 2002-2006, Kenneth Hamlett was publisher and head writer for UNSIGNED Music Magazine, an online publication with over 100,000 readers. Prior to establishing UNSIGNED, Hamlett was a business solutions analyst and spent 15 years formulating and writing proposals for supply chain business solutions. He is a graduate of the New York Institute of Photography.