The term book value per share refers to a metric that allows investors to understand if a share of common stock is selling in excess or a discount to its book value. When selling at a price above book value, the stock is said to be selling at a premium to book.
Book Value per Share = (Total Equity - Cost of Preferred Stock) / Total Number of Shares Outstanding
Return on investment measures allow the investor-analyst to understand the company's ability to provide investors with an acceptable return on their money. This is usually assessed by examining metrics such as net worth, returns on equity or assets, earnings, economic value added, and dividends. Return on investment metrics provide analysts with a way to determine a fair price to pay for a share of common stock. One of the ways to understand return on investment is by measuring a company's book value per share.
An investor-analyst can better understand the market's sentiment towards a company is by calculating its book value per share. When the price of common stock is higher than its book value, it is said to be selling at a premium to book. When the price of common stock is lower than its book value, it is said to be selling at a discount to book. A high premium to book value indicates the market is willing to pay more for a share of stock today because it expects the stock to be much more valuable in the future. When a stock sells at a discount to book, investors are sending a signal to the market that the company may not perform well in the future, so paying less than book value for a share of stock lowers their risk in the event of bankruptcy and forced liquidation.
The manager of a large mutual fund would like to understand if Company ABC current price of common stock is selling above or below book value. He asked his analytical team to review the balance sheet of Company ABC's most recent annual report as well as the details of the preferred shares it has issued. The team found the following:
Company ABC has 3,000,000 shares of common stock issued to the public and the current market price per share was $15.50. Using this information the team calculated the book value per share as:
= ($6,500,000 + $57,350,000 + $3,000,000) - ($10,500,000 + $1,050,000) / 3,000,000
= $66,850,000 - $11,550,000 / 3,000,000, or $18.43 per share
Since Company ABC was selling at a discount to book value ($15.50 market prices versus $18.43 book value), the manager decided to start selling its fund's shares of Company ABC.