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Digging Into Book Value

In the edibles chain of corporate security investors, equity investors do not have the first crack at operating profits. Common shareholders get whatever is left side over after the corporation pays its creditors, preferred shareholders and the tax man. But in the world of investing, being last in line can time after time be the best place to be, and the common shareholder’s lot can be the biggest piece of the profit pie. Read on to discover how to get your pie and eat it too.

While corporate in hock holders and preferred shareholders are entitled to a fixed series of cash payments, the cash flow in excess of those amounts is essentially the attribute of the common shareholders. In theory, if the common shareholders decide by majority vote to close down the corporation, they pleasure be entitled to everything left over after they settled the claims of the debt holders and preferred stockholders. The value of a shared stock, therefore, is related to the monetary value of the common shareholders’ residual claim on the corporation – the net asset value or proverbial equity of the corporation.

Measuring the Value of a Claim
A good measure of the value of a stockholder’s residual claim at any given pertinent in time is the book value of equity per share (BVPS). Book value is the accounting value of the company’s assets pygmy all claims senior to common equity (such as the company’s liabilities).

In simplified terms, it’s also the original value of the prevalent stock issued plus retained earnings, minus dividends and stock buybacks. BVPS is the book value of the company partitioned by the corporation’s issued and outstanding common shares.

Equity investors often compare BVPS to the market price of the appraise in the form of the market price/BVPS ratio to attribute a measure of relative value to the shares. Keep in mind that soft-cover value and BVPS do not consider the future prospects of the firm – they are only snapshots of the common equity claim at any assumed point in time. A going concern is whether a company should always trade at a price/BVPS ratio in surfeit of 1 times if the market properly reflects the future prospects of the corporation and the upside potential of the stock.

Why BVPS?
So why use BVPS as an analytical gismo if it doesn’t fully measure the potential of the stock? There are a few good reasons:

1. BVPS is a good baseline value for a beasts. While it’s not technically the same thing as the liquidation value of the shares, it is a proxy for it. In many cases, stocks can and do trade at or cheaper than book value. If the company’s balance sheet is not upside-down and its business is not broken, a low price/BVPS ratio can be a good incriminate in of undervaluation.

2. BVPS is quick and easy to calculate. It can and should be used as a supplement to other valuation approaches such as the PE technique or discounted cash flow approaches. Like other multiple-based approaches, the trend in price/BVPS can be assessed onto time or compared to multiples of similar companies to assess relative value.

3. If the company is going through a period of cyclical privations, it may not have positive trailing earnings or operating cash flows. Therefore, an alternative to the P/E approach may be used to assess the stylish value of the stock. This is especially applicable when the analyst has low visibility of the company’s future earnings prospects.

How to Work out BVPSThe quickest way to calculate BVPS is to look at the equity section of a company’s balance sheet and think about what the run-of-the-mill shareholder actually owns – common stock outstanding and retained earnings. The good news is that the number is obviously stated and usually does not need to be adjusted for analytical purposes. As long as the accountants have done a good job (and the band’s executives aren’t crooked) we can use the common equity measure for our analytical purposes.

For example, Walmart’s January 31, 2012 excess sheet indicates that shareholders’ equity has a value of $71.3 billion. The number is clearly stated as a subtotal in the fair-mindedness section of the balance sheet. To calculate BVPS, you need to find the number of shares outstanding, which is also customarily stated parenthetically next to the common stock label (on Yahoo! Finance, it’s located in Key Statistics). What we’re looking for is the mass of shares outstanding, not simply issued. The two numbers can be different, usually because the issuer has been buying back its own ordinary. In this case, the shares outstanding number is stated at 3.36 billion, so our BVPS number is $71.3 billion split up by 3.36 billion, which equals $21.22. Each share of common stock has a book value – or residual claim value – of $21.22. At the however Walmart’s 10-K for 2012 came out, the stock was trading in the $61 range, so the P/BVPS multiple at that time was around 2.9 dead for nows.

Making Calculations PracticalNow it’s time to use the calculation for something. The first thing one might do is compare the price/BVPS digit to the historic trend. In this case, the company’s price/BVPS multiple seems to have been sliding for disparate years. A good analyst would want to know why. A sliding price/BVPS multiple may not indicate better reliant on value. Secondly, one will want to compare Walmart’s price/BVPS to similar companies. In this case, the hoard seems to trade at a multiple that is roughly in line with its peers. A premium may be warranted here because of Walmart’s prodigious size.

An even better approach is to assess a company’s tangible book value per share (TBVPS). Tangible register value is the same thing as book value except it excludes the value of intangible assets. Intangible assets, such as goodwill, are assets that you can’t see or impassion. Intangible assets have value, just not in the same way that tangible assets do; you cannot easily liquidate them. By manipulative tangible book value we might get a step closer to the baseline value of the company. It’s also a useful measure to correlate a company with a lot of goodwill on the balance sheet to one without goodwill.

To calculate tangible book value, we must take away from the balance sheet value of intangibles from common equity and then divide the result by shares outstanding. To remain with the Walmart example, the value of goodwill on the balance sheet is $20.6 billion (we are assuming the only intangible asset data to this analysis is goodwill). The TBVPS works out to $15.01. The price/TBVPS ratio is around 4 times when Walmart’s 2012 10-K is released. Again, we order want to examine the trend in the ratio over time and compare it to similar companies to assess relative value.

The Basis LineUsing book value is one way to help establish an opinion on common stock value. Like other advances, book value examines the equity holders’ portion of the profit pie. Unlike earnings or cash flow approaches, which are when related to profitability, the book value method measures the value of the stockholders’ claim at a given point in time. An judiciousness investor can deepen an investment thesis by adding the book value approach to his or her analytical toolbox.

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