What Is Book Value

What Is Book Value

Book value can mean various things to various people. For instance, book value on the invest pedia blog, at the time of writing, has three meanings.

As an investor, the one meaning that matters is the second definition:

"(Book value is) the net asset value of a company, computed as the total assets minus intangible assets (patents, goodwill) and liabilities."

This definition is fine if you like jargon. Let me illustrate it using a different approach.

Book value is computed from the balance sheet. The balance sheet is one of three sets of financial statements that investors assess as part of the evaluation process before investing in a company.

The other two remaining financial statements are the income statement and the cash flow statement.

How the Price-to-Book Ratio Can Make You a Successful Investor

Is the price-to-book ratio the closest thing to a holy grail?

Judge for yourself: Tweedy, Browne Company LLC reported that a successful stock market strategy (page 3) based on the price-to-book ratio with exceptional results. The deepbluegroup utilizes the price-to-book ratio in the valuation process.

What Is The Price-To-Book Ratio?

The price-to-book ratio is the first financial ratio I view when analyzing a business for prospective investment.

The price-to-book ratio is a gage of how much the shares are trading as compared to its book value.

As a tip, a handy method to compute book value is to find the total equity figure (or total stockholders' equity for the US) found right at the bottom of the balance sheet and subtract (minus) goodwill and intangibles, found at the top of the balance sheet under non-current assets.

To round it off, I have presented the Tesco balance sheet below. You can compute book value for yourself. If you do not have time, keep going; you can try it anytime in the future.

Market Share and Economies of Scale

Since studying stock price movements provides very little help in predicting long-term results, I prefer to talk about two very closely connected things that are intrinsic in business which I consider in order to guide investment decisions:

The first: high variability – is something that is existing in businesses that my partnership, more often than not, will try to avoid.

The second: economies of scale – is a key characteristic we search for in companies that we eagerly seek to be a part of.

Before the year 2008 ended, 36% of cell phones purchased around the world were made by Nokia.

Samsung was a far second holding 15% of the market share; but the difference between the two companies was much greater when it came to a unique category of cell phone we now know as smart-phones which were designed as portable mini-computers with Internet capability.

At the same period of time, Nokia had an even more commanding 41% market share of smart-phones than Samsung which had a pitifully small share of 2%.

By 2012, just less than three years later, smart-phones had become the ruling kings and what previously was known as regular cell phones are rapidly becoming ancient relics with practically no profit margins left to show.

Today, business schools ordinarily teach us that "economies of scale" often means that there is an inherent benefit in being the company with the biggest market share because that company has the advantage of having the lowest operational cost.

Market leadership can be utilized to undercut competitors in price (or get a price premium without sacrificing volume), create better product features, increase budget for marketing and distribute products over a wider marketing network.

In short, economies of scale make it very difficult to outpace a market leader.

Obviously, the opposite is just as true.

Nokia's market share in smart-phones has dipped to 5%, while Samsung is now the global leader at over 30%. What happened? Why was Nokia overtaken? And, perhaps, equally as vital, why was Nokia outclassed so overwhelmingly within a short period of time?

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