Book value: what is it, and how do you calculate it?

Price to Book Ratio
Price to Book Ratio

A company’s book value is the value of all its assets minus the value of all its liabilities. It can therefore be regarded as the “net worth” of a business.

It is calculated by the company’s finance department and checked annually by its independent auditors, as is required by the law. It is then published in the company’s annual report.

Book value can go by other names: net assets, shareholders’ funds, shareholders’ equity or simply equity.

A company’s assets include “tangible” assets such as buildings, land, machinery and stock, as well as intangible assets such as patents and other “intellectual property” (IP).

Another intangible asset you will also see often is “goodwill”.

This can be an awkward concept to grasp, but is in essence an attempt to capture what a company is worth beyond its identifiable assets. It is normally used when one company has taken over another.

Liabilities include bank debt, any bonds the company has issued and money owed to suppliers or the tax authorities.

Lease obligations and any deficit in a defined benefit pension scheme are also deemed to be liabilities (if the scheme has a surplus it counts as an asset).

Details of all a company’s assets and liabilities are listed in its “balance sheet”, an essential component of its annual report and accounts.

They are also listed in the “interim” report for the first half of the financial year; however, in this case the figures will not have been checked by an independent auditor.

Sometimes companies publish unaudited summaries of their assets and liabilities more frequently.

How do you calculate a company’s book value?

You will need the company’s most recent annual report and accounts, specifically the section headed “balance sheet” or sometimes “financial position”.

Be sure to find the balance sheet for the group, not for any of its individual subsidiaries or for the parent company alone, without the subsidiaries.

When we are dealing with the entire group – the parent company plus all its subsidiaries – you will sometimes see the various financial statements (the income statement, balance sheet, cash flow statement etc) described as “consolidated”.

The balance sheet will give the total values of the company’s assets and liabilities but, as ever in investment, things can get complicated.

It is common for businesses to divide both their assets and liabilities into “current” and “non-current” totals.

Broadly speaking, the latter are permanent while the former can fluctuate throughout the year.

For example, non-current assets include land and property, while current ones include stock, the value of invoices issued but not yet paid and cash in a bank account.

Examples of non-current liabilities include outstanding bonds, whereas current ones include the value of bills received from suppliers but not yet paid.

Worked example

Let’s find Tesco’s book value. We’ll go to its most recent annual report and accounts, for the year to 24 February 2024 and find the balance sheet on page 131.

Helpfully, Tesco has stated the “net assets” figure – assets minus liabilities – so we don’t need to do any sums. It gives the net assets figure as £11.7bn.

You can also find the information on the “financials” tab of the Tesco page of Fidelity’s website – here, the book value is called “total equity”.

How to use the book value

Book value is often compared with a company’s market value to arrive at a “price-to-book” ratio or p/b ratio.

“Value” investors may use this ratio to help identify undervalued stocks.

If the market value is less than the book value, it may appear that the company is cheaply valued. However, there are a number of nuances to bear in mind if you want to take this approach.

First, some investors and analysts believe that it’s best to ignore the value of intangible assets on a company’s balance sheet, on the basis that these assets may be difficult or impossible to sell.

While this may be true in the case of, for example, goodwill, other intangible assets such as patents could be sold for handsome sums in some circumstances.

Equally, while land will often find a ready buyer, certain tangible assets might be harder to sell.

Imagine if a business has had a piece of machinery custom-made for a task that no competitor performs: that machinery might fetch little more than scrap value if sold.

Then there is the question of depreciation.

Companies tend to reduce the book value of assets (other than land) in each successive year, typically according to a formula. But the figure arrived at may not represent the actual sum that the asset would fetch on the market.

This should remind us of the wider point that valuing an asset can be a subjective process and there can therefore be no certainty that if the asset were sold it would fetch the sum at which it was valued in the company’s accounts

The only true validation of the value of an asset comes when it is sold.

Company managers and their auditors use a variety of methods to value assets, but in many cases the values they arrive at are, in effect, educated guesses.

Finally, remember that the book value will date back to the day on which the accounts were compiled, which is likely to be several months in the past.

Richard Evans is an investment writer at Fidelity International.