The book value refers to the tangible asset value of any company. Tangible value here is used to refer to any assets that can be felt, seen, or touched, such as inventory, plants, equipment, cash, offices, or properties. Because of this tangible factor to book value, it is often referred to as Net Tangible Assets.
Finding a company’s book value is not particularly hard if you have a company’s balance sheet. To determine this number, all that you have to do is to look at the shareholder’s equity. From this number, you simply subtract out all of the intangible items’ values, such as goodwill. What remains is the book value of tangible assets that the company has.
Book value, or the net tangible assets, that companies possess proves to be extremely important. You ought to analyze a company’s balance sheet directly from them, not from a third party website. This means that the book value figure may not be determined on the balance sheet. Coming up with the figure is just a matter of taking all of a company’s assets and subtracting the intangible types of assets from the figure. You will then be looking at the company’s true components, including properties, office buildings, phones, computers, chairs, etc.
In the past, this book value represented the ultimate measurement for value investors who were looking for bargains on stock prices of companies. This meant that higher assets, and thereby book values, proved to be the principal measurement for making value investing decisions. During the last twenty or so years, investors who seek out value have shifted away from the importance of the dollar values of assets to preferring companies that create higher earnings using a smaller base of assets.
As an example of why book value is less valuable than smaller asset bases with earnings creation, consider a company that possesses thirty million dollars in physical assets and earns $10 million per year. Look at another company that makes the same $10 million in earnings while having $50 million in asserts. Relationships between the asset base of a company and its earnings are well known and established.
This means that doubling the earnings of the company with $30 million would require investing another $30 million. This would leave the business with $60 million in assets and $20 million in earnings. Doubling the earnings of the company with $50 million in assets would similarly require adding another $50 million in assets. The business would then own a $100 million of assets and create the same $20 million in earnings per year.
The new company with $100 million in assets has the higher book value to be sure. But the smaller asset company only needed to retain $30 million in earnings in order to double its profits. The $20 million difference could be used for expansion of the business, paying dividends, or buying back shares. So while higher book values are still important, higher returns on assets are actually more significant and beneficial.