Book value vs market value stocks

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Bank goes into bankruptcy. Why these CDOs could be worth nothing. Does the bailout have a chance of working? More on the solution. Google Classroom Facebook Twitter Email. So let's see where we left off. We were studying the balance sheet of this Bank A, I think that's what I called it.

What Is the Difference Between Book Value & Market Value Per Share of Common Stock? | Finance - Zacks

And we said, OK on the assets side, had some government bonds, had some AAA corporate bonds, some commercial mortgages. And I explained little bit about what those are. And I have several videos where I explain that in more detail. And how they probably led, or most definitely led, to the housing bubble.

And then we have a little bit of cash on top of that. On the liability side, the bank just owes a lot of money to people. If this were a commercial bank, kind of your Bank of Americas, or your Chases of the world, then one of the liabilities here would have also been the deposits of the people who keep their money at the bank.

But we're not going to assume that. This could be just kind of any bank. Actually, this could be any type of financial institution. Frankly, it doesn't have to be a bank. This could be the balance sheet of a hedge fund, or a private equity firm, or pretty much any type of financial institution. But anyway, back to where we were in the example.

We said, and we learned it in the first video, and we learned it in the balance sheet video, that if you take your assets and you subtract out your liability-- so you take what you have, you subtract out what you owe, you're left with what you're really worth.

And that's called your equity. And if you're a publicly traded company, actually you don't have to be publicly traded, but if you're a corporation, that's called your shareholders' equity. And what does that mean? Well that means the people who own a stake in the company, or the shareholders, they share this piece. And just to hit the point home, and I think this is an important one because I feel like people kind of talk past this.

There's two notions, there's your book value of equity, and that's the value of the equity that comes out of your balance sheet.

So if you assume that everything, all of these numbers, are accurate-- and we're going to think a lot about what it means to have an accurate number here-- and you assume that all of these numbers are accurate. Then the number that pops out on the equity side, that is a book value of your equity. And just as an example, I said well let's say that Bank A is a public company. It has million shares. And you're saying, wait Sal, that doesn't make sense, we all know that the stock market is a wild ride, especially banking stocks.

They swing left and right and up and down. And how can you tell me that you know just by looking at a balance sheet, you can give an exact amount for what its equity value is?

And that is an important distinction. Let me scroll down a little bit. Maybe I'll erase this. Actually, let me clear this out.

I think it's a distraction. You might just want to watch the video on mortgage-backed securities and collateralized debt obligations if you need a refresher there. So what does it mean when, I'm telling you right now that you can look at it company's balance sheet, and if you believe what they say, you can actually calculate a book value per share.

So why do stocks fluctuate wildly left and right? It actually tells you a lot about what the market thinks about a company's balance sheet. Let me fill this in. Now let's say we go on to Yahoo Finance and we type in the ticker symbol for this bank-- Bank A, whatever we want to call it.

So what is happening here?

And just to make a point here, when you look up a share price in the stock market, or even better, when you buy a stock on the stock market, that money is not going to the company.

The company initially raises money by selling shares. And that's often done with an initial public offering. They will sell some shares directly to the market. And that money goes directly to the company. Or they might do it in an offering, and we'll talk more about that later. It is going to the previous person who held that share. That's why it's called a secondary market. It's not going to the company.

So it's just a bunch of people trading the share price. And the only reason why that share price really fundamentally matters to the company is if the company were to raise money at a future date. I didn't buy from the company. But that's not the topic for this. And actually, the more I think about it, I really should do videos on all of these concepts. And so if the book value is understated, that means that either the assets are understated, or the liabilities are overstated.

Most times the liabilities are pretty easy to get a handle on. Sometimes pension liabilities or some type of litigation liabilities, that's hard to get a grasp on. But most times, you can look at a balance sheet and you say, OK this is the money they owe. That's not too hard to value. What is often very interesting to value are the assets on a balance sheet. Then you say, either these assets or somehow being undervalued or the company might have some assets that somehow are not captured on the balance sheet, right?

Maybe they're intangible assets. Or there's some type of earning power that in some way is not captured here. I think when I originally did the videos on balance sheets, I actually talked about you can't quantify charisma and good looks. And so that's maybe why I have more assets than might balance sheet might predict. Well, this notion is the same thing, but on the company level.

That's the corporate equivalent of charisma and good looks. They say, just by their brand they're able to make more money than everyone else. They're able to do more with whatever assets we give them. So I'm willing to pay a premium to their book value.

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And whether or not that's true, that's a tough case. I think that argument can very easily be made with a company like Coca-Cola, where it does have a very powerful brand.

Where that brand and that formula, that secret formula, really are the value of the firm, and they probably aren't captured on their balance sheet.

With a bank, I'd be a little more skeptical of paying a significant multiple of this, right? Here, what multiple are we paying? If this is the market value-- so let's say this is the stock price, or the market stock price-- I'd be skeptical of paying two times the book value. But it's actually not hard to find a lot of companies that are trading at far more than two times the book value.

So that's what it means. Or maybe one of these assets are worth more.

But maybe the shareholders say, oh no that's really worth a million dollars or something, I don't know. And the market cap of the company is really what's the market's guess of what the shareholders' equity is? So 12 times million, or let's say 0. I told you for all the reasons, maybe the brand is worth a lot, or they have some secret formula, or one of these assets somehow is understated.

That's the situation where the market price is above the book value. Well if we say 3 times 0. Or another way of viewing it, is that this is the market's guess, or you could call it the market value of the equity. This is the market's guess of the value of this company's equity.

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We don't buy it. And it's probably because they think that one of these things on the left-hand side of the balance sheet, one of these assets, are worth less than what the bank says they're worth.

It could be that one of these liabilities is worth more. Maybe there's some type of environmental liability that the company is somehow understating. But let's not get too complicated right now, I'll do a bunch of videos on that. But when the market value, or the market cap, is below the book equity, that's the market just saying, hey we're calling your bluff. Something here doesn't smell right. Something here isn't worth what you say it's worth.

And I just realized that I'm out of time. And I will continue this in the next video.