Book value and liquidation value are tools used to understand the worth of a company before investing.
Let’s start with a quick comparison of both tools.
Book Value Vs Liquidation Value – Quick Comparison
Book value is the company’s assets value as mentioned in the balance sheets published by the company whereas Liquidation value is the net value of the physical assets of a company.
Liquidation value is mostly lesser than the book value because book value contains historical pricing whereas the liquidation value provides the current market value of an asset is liquidated after deducting the depreciation.
You can have a quick look at the 4 major differences between book value and liquidation value in the quick comparison table below –
|Book Value||Liquidation Value|
|1.||Book value = Total assets – Total liabilities||Liquidation value = Total assets – Depreciation|
|2.||Represents the historical cost of assets||Provides the current market value of assets|
|3.||The company publishes “Book Value” quarterly or annually||Declared at the time of business shut down or in the auction|
|4.||Intangible assets may or may not include depending upon the company’s policy||Intangible assets are not included|
Let’s discuss the difference between book value and liquidation value in detail.
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What is Book Value
Book value is the company’s worth as per its balance sheet. Book value provides the value of assets after deducting the liabilities on the balance sheet.
The book value provides you an overview of the company assets shown in the balance sheet.
Since the balance sheet contains asset value at the previous cost, the actual value of assets could be lower (or higher) than the current market value.
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Significance of Book Value in Stock Analysis
Book value gives you a clear picture of a company’s value if the company’s all assets are liquidated along with all liabilities cleared.
You can get an overview of a company’s total worth by calculating the book value that helps you in multiple ways –
#1. Determine stock value
Whether a stock is undervalued or overvalued (you can decide if you should buy, sell, or hold the equity shares).
#2. Conduct stock market analysis
You can compare multiple companies or stocks to understand the potential of shortlisted stocks.
#3. Understand the working capital of a company
You can evaluate the working capital to understand if a company has sufficient liquid resources to perform the operational expenses.
#4. Calculate the financial ratios
You can calculate various financial ratios while doing the fundamental analysis of a company. Financial ratios like – BVPS and P/B ratio
Book value is one of the major components to check whether a company’s stock price is justified or not. You can use metrics like Book Value Per Share (BVPS) and Price to Book (P/B) ratio.
A. Book Value Per Share (BVPS)
Book value per share is the ratio of a company’s net asset value divided by its total number of shares.
You can use BVPS to check whether the share price is undervalued or overpriced.
If the BVPS is higher than the market value of a share, then the stock price is undervalued. On the other hand, if the BVPS is lower than the market price of a share, then the share price is overvalued.
B. Price to Book (P/B) ratio
The Price to Book (P/B) ratio is the ratio of a company’s current share price to the book value of the company’s share.
P/B Ratio = Market Price per Share / Book Value per Share
You can use the P/B ratio to validate if the company’s price is valued properly. P/B ratio is valued in numbers such as 0.5, 1.0, 2.0, 3.0, and so on.
- A P/B ratio of 1.0 means that the share price is trading in line with the BVPS of the company.
- A P/B ratio below 1.0 shows that the stock price may be undervalued.
- A P/B ratio above 1.0 means the stock price is trading at a higher value than the company’s BVPS.
Understanding these factors helps you predict whether the stock price will go up or down in the future.
Limitations of Book Value
#1. Periodic reporting
Since a company publishes its Balance Sheet quarterly or annually, you can’t know the actual book value of the company in between the timeframe, and making decisions on past numbers may lead to improper analysis.
#2. Historical pricing
Most companies represent historical figures of their assets. They don’t account for the actual depreciation and appreciation in asset values but represent figures based on fixed accounting principles. That may lead to a discrepancy in the price analysis based on book value.
#3. Intangibles are excluded
Intangibles like intellectual property or branding are not included in calculating the book value.
Nowadays intangible assets are much more valuable and not including them difficult to value.
What is Liquidation Value
Liquidation value is the net value of a company’s physical (tangible) assets such as property, buildings, furniture, plant and equipment, and inventory.
If a company shuts down its business, what would be the value of the company if its physical assets are sold that becomes the liquidation value.
You can’t include intangible assets such as patents, copyrights in the company’s liquidation value.
However, if a company is sold (not liquidated) then you can determine the company’s going concerned which is the combination of liquidation value plus intangible assets.
How it works
- Analyze the balance sheet of the company to know the assets and liabilities
- Companies assign a recovery percentage to each asset to get the real asset value as a 100% recovery ratio of cash, but the recovery ratio of the plant would be 50%.
- Liabilities are deducted from the real asset values
- The balance amount would be the Liquidation value of the company
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Significance of Liquidation Value in Stocks
Liquidation value is important for a value investor to check how much of the money invested in that company would be returned if the company goes bankrupt.
That means you can check the potential of a company share by analyzing the liquidation value.
If a company is profitable and growing, then the liquidation value of that company would be much lower than its share price.
If a company’s growth is declining and the share price goes below the liquidation value, that means the company may shut its business sooner or later.
Limitations of Liquidation Value
#1. Not an accurate tool
Liquidation value is not an accurate tool for a growing company that got a sudden fall because of a couple of wrong management decisions but maybe in the future the company brings changes in the management and it starts recovering.
#2. Exclude passive factors
Brand goodwill, investor support, or even government control are some passive factors that affect the liquidation value. For example, Yes bank was almost collapsed but manage to sail through with the help of RBI and the Indian government.
Now you understand the difference between book value and liquidation value. Book value gives you a better understanding of what would be the share price in the future.
Liquidation value gives clarity about whether the company would be profitable in the future or not.