RCMA 4: BOOK VS. MARKET VALUE

Book vs. Market Value

Market value is the price currently paid or offered for an asset in the marketplace. Essentially, the market value of an asset is a quantified reflection of the perception of the value of the asset by the market.

Book value is a concept related to the value of an asset as recognized by a company on its balance sheet. Book value equals the original purchase cost of an asset adjusted for any subsequent changes including depreciation, amortization, or impairment.

A significant variation between market value vs book value may arise if a company purchased an asset in the past that has markedly increased in value.

Book value and market value are two fundamentally different calculations that tell a story about a company's overall financial strength. Comparing the book value to the market value of a company can also help investors determine whether a stock is overvalued or undervalued given its assets, liabilities, and its ability to generate income.

What is Market Value?

Market value is the current prevailing price for an asset in the marketplace.

Unlike the more stable book value, which is rarely adjusted, market value is highly dynamic. Market value can be easily determined for highly liquid assets such as equities or futures. The financial assets are generally traded on centralized exchanges, and their prices can be easily discovered.

However, the determination of the market value of illiquid assets is a challenging process. The absence of a constant network of buyers and sellers, as well as the complexity of some of the underlying assets (think about real estate or artwork), requires a time-consuming process to identify the reasonable market value.

The term “market value” is sometimes used synonymously with “market capitalization” of a publicly-traded company. The market value of a company is calculated by multiplying the current stock price by the number of outstanding shares that are trading in the market.

Example: The market value of a publicly-traded company may fluctuate every second due to the fluctuations in its stock price.

What is Book Value?

Book value (also known as carrying value or net asset value) is an asset’s value as recorded on a company’s balance sheet. In essence, book value is determined as the original cost paid for the asset’s acquisition, adjusted for any depreciation, amortization, or impairment attributable to the asset.

From basic accounting principles, we can derive that the book value helps determine the value of a company’s equity. In this sense, we’re talking about the equity value that the shareholders should receive in case of the company’s liquidation.

In addition, book value is frequently used to determine whether an asset is under- or overpriced. It can be determined by comparing the difference between the asset’s book and market values.

Example: One of the key applications of the difference between an asset’s book and market values is the company’s valuation. If the company’s book value exceeds its market value, it can be an indicator of a loss of confidence in a company from the investors. It can be the result of the company’s business problems, poor economic conditions, or simply investors erroneously undervaluing the company. Alternatively, if the company’s market value exceeds its book value, it is an indicator of the investors’ belief in its growth potential.

Is Book Value the Same as Fair Value?

The book value of an asset refers to its cost minus depreciation over time. It is the value of an asset based on its balance sheet. The fair value of an asset reflects its market price; the price agreed upon between a buyer and seller.

Is Book Value a Good Indicator of a Company's Value?

Yes, book value can be a good indicator of a company's value. If the book value per share is higher than its market value per share then it can indicate an undervalued stock. If the book value per share is lower than its market value per share, it can indicate an overpriced, or overvalued stock.

What Does a Negative Book Value Mean?

A negative book value means that a company's liabilities are greater than its assets. This indicates a company is possibly insolvent. This, however, does not mean that a company is a bad investment. One would need to dig further to understand why the book value is negative.

PRACTICE QUESTIONS

1. What represents the total dollar market value of a company's outstanding shares of stock.

A. Market capitalisation

B. Book Value

C. Book Value of an asset

D. Market share

2. What indicates an asset's value that is recognized on the balance sheet.

A. Market capitalisation

B. Book Value

C. Book Value of an asset

D. Market share

3. What is value paid by a willing buyer and willing seller;Not found on financial statements

A. Market capitalisation

B. Book Value

C. Market Value of an asset

D. Market share

4. Common stockholders' equity; found under stockholder's equity

A. Market capitalisation

B. Book Value of a company

C. Market Value of an asset

D. Market share

5. Book values vs market values in terms of time - identify which uses historical and current

A. book: historical ; market: current

B. book: historical ; market: historical

C. book: current ; market: current

D. book: currecr ; market: historical

ANSWER KEY:

A. Market capitalisation
C. Book Value of an asset
C. Market Value of an asset
B. Book Value of a company
A. book: historical ; market: current

References:

Murphy, C. B. (2024, April 30). Book Value vs. Market Value: What's the Difference? Investopedia. https://www.investopedia.com/ask/answers/how-are-book-value-and-market-value-different/

Team, C. (2023, October 4). Market Value vs Book Value. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/accounting/market-value-vs-book-value/#:~:text=Essentially%2C%20the%20market%20value%20of,company%20on%20its%20balance%20sheet.