Definition: Book value of equity, also known as shareholder’s equity, is a firm’s common equity that represents the amount available for distribution to shareholders. The book value of equity is equal to total assetsminus total liabilities, preferred stocks, and intangible assets.
What Does Book Value of Equity Mean?
What is the definition of book value of equity? In general, the book value of equity depends on the industry that a company operates in, and how it manages its assets. Companies that are expected to grow and generate higher profits in the future, typically have a book value that is lower than their market value, i.e. the value of the company that is determined by the stock market because they can generate relatively high profits from their assets.
Conversely, companies that are less growth-oriented and more value-oriented tend to have a book value of equity that is greater than their market value. In fact, this means that the market is not that confident in the company’s ability to generate profits in the future, but, on the other hand, value investors believe that the market is not correct.
Let’s look at an example.
Example
Andy considers investing in a retail company. The firm has a market value of $160,000 and a book value of $120,000. The shares outstanding are 5,000. Therefore, the market value per share is $32, and the book value per share is $24. Since the company’s market value is greater than its book value, the market expects a return of 18%.
Andy is a new investor in the retail company. Therefore, he will buy 100 shares for $25 each, paying $2,500, expecting a return of 18% on the book value per share, which is $24 x 18% = $4.32 per share. Calculating his profit based on the market value per share, Andy will realize a return of $4.32 / $32 = 13.5%, which is less than 18%.
If Andy was an existing investor, he would sell his shares at the market value of $32 because the expected market return of 18% is higher than the actual return of 13.5%. Therefore, Andy would look for securities with a higher actual return, considering the retail company overpriced.
The BV of equity is a useful valuation tool to identify overvalued and undervalued stocks. Generally, investors base their investment decisions on the expected market return. However, the BV of equity indicates the value that the company returns to its shareholders.
Summary Definition:
Define Book Value of Equity: The BVOE is a financial calculation that measures the amount of assets shareholders own outright and are able to distribute to themselves.
