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Book Value Definition
In accounting, the book value of an asset is its written down value in the balance sheet after deducting the accumulated depreciation from its purchase cost. The book value of a company is the net worth of the company calculated by deducting the company’s outstanding liabilities and intangible assets from the total value of the company’s assets.
A Little More on What is Net Book Value
The book value of a firm is important to calculate the book value of its shares. The book value of the shares is calculated by dividing the book value of the firm by the number of shares held by the shareholders. It is the value the shareholders would theoretically receive for each share if all the assets of the company liquidate.
This value can be used for comparing it with the market value of the company to estimate whether the stocks are overpriced or underpriced.
In the United Kingdom, the book value is known as the net asset value. The same is also known as the net book value.
The name book value came from the accounting practice of recording that value in the book or balance sheet. The book value of an asset may stay constant over the time, but the collective book value of the company may increase by accumulating the earnings generated through asset use.
Comparing book value with the market value of the shares is an effective technique to evaluate the pricing of the shares. When mark-to-market valuation is not applied to the assets whose value may increase or decrease with time, this method may not work accurately.
If the companies follow the uniform method of accounting, the price-to-book ratio can be useful for value comparison between the companies operating in the same industry. This method will fail if the companies belong to different industries as companies operating in certain sectors record their assets as historical cost while in other sectors, they mark their assets to market. So, a high price-to-book ratio doesn’t necessarily indicate a premium valuation and a low price-to-book ratio doesn’t signify a discount valuation.
References for Net Book Value
Academic Research on Net Book Value
Relative valuation roles of equity book value and net income as a function of financial health, Barth, M. E., Beaver, W. H., & Landsman, W. R. (1998). Journal of Accounting and Economics, 25(1), 1-34. This study aims to check predictions that the multiples of pricing rely on an increase in the explanatory power of equity book value (net income) increase – decrease as the financial health drops. The test was carried out using a sample of 396 bankrupt firms and also a test using more, pooled sample both lead to inferences that were consistent with the predictions. The discoveries are valid to the inclusion of controls for industry, return-on-equity, size, and volatility of equity returns. There’s a multiplicity on equity book value, and net income and incremental explanatory power differ in a predictable form across three industries that appears illustrative and chosen based on the likely extent of an intangible asset that cannot be recognized.
Valuation characteristics of equity book value and net income: Tests of the abandonment option hypothesis, Barth, M., Beaver, W. H., & Landsman, W. (1996). The hypothesis that affects the abandonment option on net income taxation characteristics and equity book value is tested in this paper. Predictions have to lead to stating that pricing multiple on, and explanatory power of book equity increases as firms approach liquidation. There is variation in the characteristic of net income and equity book value valuation across three illustrative industries, and the selection is based on the extent of unrecognized intangible assets.
Changes in the value-relevance of earnings and book values over the past forty years, Collins, D. W., Maydew, E. L., & Weiss, I. S. (1997). Journal of accounting and economics, 24(1), 39-67. This article focuses on the investigation of systematic changes in the value relevance of book value and earnings over some time. Three basic findings are reported, firstly, on the contrary claims in the professional literature, a combination of value-relevance of earnings and book values has not been rejected for the past forty years and also seems to have some slight increment. In conclusion, a number of shift in value-relevance and earnings to book values are illustrated by the increase in frequency and magnitude of one-time items amongst other factors
Earnings, adaptation and equity value, Burgstahler, D. C., & Dichev, I. D. (1997). Accounting review, 187-215. This article works on developing and testing an option-style valuation model. The main prediction of this model is that equity value is a convex function of book value and earnings, and the function relies on the relative values of earnings and book value. There’s a provision of the measure of how the organization’s resources are presently used, and this provision is by earnings. Book value gives a measure of the value of the company’s resources not dependent on how the resources are presently used.
Deflators, net shareholder cash flows, dividends, capital contributions and estimated models of corporate valuation, Akbar, S., & Stark, A. W. (2003). Journal of Business Finance & Accounting, 30(9‐10), 1211-1233.
Equity valuation and negative earnings: The role of book value of equity, Collins, D. W., Pincus, M., & Xie, H. (1999). The Accounting Review, 74(1), 29-61. An explanation for the significant increased negative price-earnings relation by the use of a simple earnings capitalization model for firms that state losses are adequately provided by this study. Also, the study hypnotizes and finds that adding the book value of equity in the valuation specification reduces negative relation. The suggestion leads to the fact that a simple earnings capitalization model is not specified and earning’s negative coefficient for loss firms is a result of the misspecification.
The value relevance of German accounting measures: An empirical analysis, Harris, T. S., Lang, M., & Mőller, H. P. (1994). Journal of Accounting Research, 32(2), 187-209. This study compres the value relevance of the measures of accounting for U.S. and German firms allocated on industry and firm size, and also check the incremental information level of earnings and changed based on a formula proposed by analyst.
Value-relevance of banks’ fair value disclosures under SFAS No. 107, Barth, M. E., Beaver, W. H., & Landsman, W. R. (1996).. Accounting Review, 513-537. This article gives evidence that fair value estimation of securities, loans and long-term debt disclosed under SFAS No. 107 gives great explanatory power for bank share prices more than what related book value gives. Contrasting to Eccher et al. (1996) and Nelson (1996), it is consistently discovered that explanatory power of loan’s fair values. More findings are gotten using a set of significant conditioning variables which includes interest-sensitive assets and liabilities and nonperforming loans. The discoveries are stronger in relation to inclusion of a first differences formulation and an additional explanatory variables.
Value creation, net present value, and economic profit, Harris, R. S. (1997). This paper makes a comparison of economic profit (economic added value) and net-present-value techniques for the evaluation of corporate investment and performance. This paper relates what is between the two approaches and sets out the conditions under which they get the same conclusions about creating value. It further states the difference in the estimation and the use and talks relating to some application difficulties.
An investigation of the effect of differing accounting frameworks on the prediction of net income, Simmons, J. K., & Gray, J. (1969). The Accounting Review, 44(4), 757-776.