Conventional Valuation Yardsticks: Book Value

Book Value

What something cost in the past is not necessarily a good measure of its value today.  Book value is the historical accounting of shareholders' equity, the residual after liabilities are subtracted from assets.

Sometimes historical book value (carrying value) provides an accurate measure of current value, but often it is way off the mark.

• Current assets, such as receivables and inventories, for example, are usually worth close to carrying value, although certain types of inventory are subject to rapid obsolescence. 
• Plant and equipment, however, may be outmoded or obsolete and therefore worth considerably less than carrying value. 
• Alternatively, a company with fully depreciated plant and equipment or a history of write-offs may have carrying value considerably below real economic value. 
• Inflation, technological change, and regulation, among other factors, can affect the value of assets in ways that historical cost accounting cannot capture. 
• Real estate purchased decades ago, for example, and carried on a company's books at historical cost may be worth considerably more. 
• The cost of building a new oil refinery today may be made prohibitively expensive by environmental legislation, endowing older facilities with a scarcity value. 
• Aging integrated steel facilities, by contrast, may be technologically outmoded compared with newly built mini-mills. As a result, their book value may be significantly overstated. 

Reported book value can also be affected by management actions.

• Write-offs of money-losing operations are somewhat arbitrary yet can have a large impact on reported book value. 
• Share issuance and repurchases can also affect book value. 
• Many companies in the 1980s, for example, performed recapitalizations, whereby money was borrowed and distributed to shareholders as an extraordinary dividend. This served to greatly reduce the book value of these companies, sometimes below zero. 
• Even the choice of accounting method for mergers-purchase or pooling of interests - can affect reported book value.

To be useful, an analytical tool must be consistent in its valuations. Yet, as a result of accounting rules and discretionary management actions, two companies with identical tangible assets and liabilities could have very different reported book values.

• This renders book value not terribly useful as a valuation yardstick. 

As with earnings, book value provides limited information to investors and should only be considered as one component of a more thorough and complete analysis.

Conventional Valuation Yardsticks: Earnings, Book Value, and Dividend Yield

Both earnings and book value have a place in securities analysis but must be used with caution and as part of a more comprehensive valuation effort.