Value of equity = Value of firm - Value of debt
- The value of the firm is the value of the firm's assets and its investments.
- The value of the debt is the value of the liability claims.
- Correspondingly, the net assets are not measured at their values.
- If they were, there would be no analysis to do! It is because the accountant does not, or cannot, calculate the intrinsic value that fundamental analysis is required.
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
- the book value per share (BPS) was $1.81 and
- the market premium was $18.19 per share.
- Investors talk of buying a firm for a number of times book value, referring to the P/B ratio.
- The market P/B ratio is the multiple of book value at the current market price.
- The intrinsic P/B ratio is the multiple of book value that the equation is worth.
- An investor will spend considerable time estimating intrinsic price-to-book ratios and asking if those intrinsic ratios indicate the the market P/B is mispriced.
- P/B ratios in the 1990s were high relative to historical averages, indicating that the stock market was overvalued.
- The medican P/B ratios (the 50th percentile) for the U.S. listed firms were indeed high in the 1990s - over 2.0 - relative to the 1970s.
- But they were around 2.0 in the 1960s.
- The 1970s experienced exceptionally low P/B ratios, with medians below 1.0 in some years.
- Is it due to mispricing in the stock market?
- Is it due to the way accountants calculate book values?
- Could this bull market have been forecast in 1974 by an analysis of intrinsic P/B ratios?
- Were market P/B ratios in 1974 too low?
- Would an analysis of intrinsic P/B ratios in the 1990s find that they were too high?
- Was it too high?