Is it better to buy a company which has a lower book value? Or does a lower book value mean that the market is pessimistic about future earnings of the company?
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1Do you mean lower book value per share?– Chris W. ReaCommented May 28, 2014 at 19:41
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I mean if the current price is $10 and the book value is say $5. Im not sure what the correct term for that is.– user15222Commented May 28, 2014 at 19:45
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2 Answers
The book value per share is the amount of the assets that will go to common equity in the event of liquidation. So higher book value means the shares have more liquidation value. Strictly speaking, the higher the book value, the more the share is worth.
There may be reasons to look for low book value, such as pursuing investments that the market considers to add significant value above the liquidation price, or otherwise to analyze the financial potential or internal dynamics of the investment. High goodwill and going concern value may not be reflected well by book value. But all else being equal, a share worth $50 liquidation value is better than a share worth $5 liquidation value.
Note that shares worth less than book value may be underpriced or they may just have very poor prospects for growth. In other words, the separate assets may be worth more than the going concern (negative value added).
The idea of a Value premium is something that is the subject of some debate. Who Killed Value? would be an article from 2001 by William Bernstein that discusses this in some depth.
Price to book value can be used as a way to determine the valuation of a company though low P/B may be a sign that the company isn't thought to have great prospects, there can also be the question of what assets does the company have that may change in value over time or be intangible in some cases.
