In the last two decades, the presence of retail investors in the Indian stock markets has increased. Naturally, investors are keen to understand the concepts that determine the value of their share holdings. Book Value and Equity Value are two such concepts.
Equity Value
A company is owned by its equity share holders. Equity value is the worth of the company in the market. The market values a company based on its own assessment of the value of the assets of the company. The worth of the company in the market is represented by its market capitalisation. Therefore, equity value can be calculated by dividing the worth of the company in the market (in other words the market capitalisation) by the total number of outstanding equity shares. Thus, the equity value of a single equity share is its market price. But, remember that this value is derived from the market’s evaluation of the worth of the assets of the company and its future growth potential.
Book Value
As the term implies ‘book value’ is the value of an equity shares according to the books of account or the financial statements of the company. The book value per equity share is calculated from the liabilities side of the balance sheet. The numerator is the total of the equity share capital and the free reserves and surplus. The denominator is the number of equity shares.
The formula is Outstanding Equity Share Capital + Free Reserves and Surplus / Number of Equity Shares.
Relevance
For the investor, the market value may seem to be more relevant because the equity value represents the price that he has to pay to become a share holder and own a part of the worth of the company irrespective of the book value of the equity share. But, the knowledgeable investor does factor in the book value of the equity share while making his investment decision.
Scenarios
Book Value = Equity Value (Market Price)
Market opinion is that the balance sheet represents the worth of the company.
Book Value < Equity Value (Market Price)
The market has factored in the future earnings potential of the company.
Book Value > Equity Value (Market Price)
The market may be underestimating the future performance of the company
Analysis
Book value is a static figure which will change only when the next financial statements are published. Equity value is dynamic because market perceptions are impacted by many variables and, therefore, keep changing from day to day. These variables include commodity prices, movement of foreign exchange rates, global interest rates, political policies, etc.
Reliability
Book value is a more reliable figure because it is based on financial statements that have been subjected to audit. But, typically book value would be driven down by depreciation. The equity value is based on several factors that do not lend themselves to quantification. But, there are some shares that are regularly traded at much above their book value. This may be because the brand value of the company may not have been adequately reflected in the financial statements. This is a hidden value that is reckoned by the market in the equity value.
The value and utility of these terms comes from a genuine understanding of their advantages and the limitations.
Book value and Equity value are two terms that most investors are confused about. Prior to investing, I was not very sure about these terms too. Based on personal experience, I can say that investors need to keep an eye on the equity value, as it does not remain the same. This ensure that the person avoids any shock of lost investment due to changes in the equity value.