Question

• For Starbucks discuss the discrepancy between a firm s stock market value and their book value relative to intangible resources that are typically undervalued or not valued at all in their balance sheets.

Answer 1

Ans:-

Book Value

Book value literally means the value of a business according to its books (accounts) that is reflected through its financial statements. Theoretically, book value represents the total amount a company is worth if all its assets are sold and all the liabilities are paid back. This is the amount that the company’s creditors and investors can expect to receive if the company goes for liquidation.

Book value of a company = Total assets – Total liabilities

Market Value

Market value represents the value of a company according to the stock market. While market value is a generic term that represents the price an asset would get in the marketplace, in the context of companies it represents the market capitalization. It is the aggregate market value of a company represented in dollar amount. Since it represents the “market” value of a company, it is computed based on the current market price (CMP) of its shares.

Market Cap of a Company = Current Market Price (per share) * Total Number of Outstanding Shares

Comparing Book Value and Market Value

Most investors and traders use both the values, and there can be three different scenarios while comparing the book value and market value.

1. Book value greater than market value: If a company is trading at a market value which is lower than its book value, it usually indicates that the market has lost confidence in the company for the moment. It may be due to problems with the business, loss of important business related lawsuits, or chances of financial anomalies. In other words, the market doesn't believe that the company is worth the value on its books or that there are enough assets to generate future profits and cash flows. Value investors often like to seek out companies in this category in hopes that the market perception turns out to be incorrect in future. In this scenario, the market is giving investors an opportunity to buy a company for less than its stated net worth, meaning the stock price is lower than the company's book value. However, there is no guarantee that price will rise in future.
2. Market value greater than book value: When the market value exceeds the book value, the stock market is assigning a higher value to the company due to the potential of the earnings power of the company and its assets. It indicates that investors believe the company has excellent future prospects for growth, expansion and increased profits that eventually raise the book value of the company. They may also believe the value of the company is higher than the current book value calculation shows. Consistently profitable companies typically have market values greater than book values and most of the companies in the top indexes meet this criterion, as can be seen from the examples of Microsoft and Walmart mentioned above. Growth investors may find such companies promising. However, it may also indicate overvalued or overbought stocks which are trading at a high price.

1. Book value equals market value: The market sees no compelling reason to believe the company's assets are better or worse than what is stated on the balance sheet.

A popular ratio that is used to compare market and book values is the price-to-book (P/B) ratio, which is calculated as per share price divided by book value per share. For example, a company has a P/B of 1, meaning that book value and market value are equal. The next day, the market price drops and the P/B ratio becomes less than 1, meaning market value is less than book value (undervalued). The following day the market price zooms higher and creates a P/B ratio of greater than 1, meaning market value now exceeds book value (overvalued). Since price changes every second, it is possible to track and spot stocks which move from P/B ratio of less than one to more than one, and time the trades to maximize the profits.

The Bottom Line

Both book value and market value offer meaningful insights to a company's valuation, and comparing the two can help investors determine whether a stock is overvalued or undervalued given its assets, liabilities and its ability to generate income. Like with any financial metric, the real utility comes from recognizing the advantages and limitations of book value and market value. An investor must determine when the book value or market value should be used, and when it should be discounted or disregarded in favor of other meaningful parameters when analyzing a company.