What is “insert company name” worth? Investors ask themselves this question every day, and determining the value of a company is at the heart of finance. Interested parties are constantly trying to estimate a company’s value – most notably when making a decision to buy, sell, or hold that company’s stock. The market values of publicly-traded companies are usually easy to determine – because the public can observe the recent trading prices for these companies’ shares on public stock exchanges. But potential investors and other parties also need to know the values of privately-held companies as well (thank goodness, because otherwise I wouldn’t have a job!). Sometimes these people estimate the value of a business based on what is reported on its balance sheet – reported shareholders’ equity, also commonly known as the book value of equity (“BVE”). This is understandable, as BVE is the only readily observable way to estimate a company’s value. This article is meant to address when BVE may provide an accurate estimate of a company’s market value, as well as when it almost certainly will not.
What is BVE?
BVE equals the value of all reported assets less the value of all reported liabilities. BVE fluctuates based on cash contributions from shareholders to the business, including retained earnings from operations (as well as net losses).
When Can BVE Approximate Market Value?
Here are some examples of when BVE may approximate market value:
Generally speaking, companies that are (any of) high-growth, service-oriented, distribution-paying, employee-centric, high-intangible assets all tend to have useless BVE. Using the public markets as an example of the disparity that can exist between book value and market value, Amazon.com, Inc.’s (AMZN) most recently reported book value ($17.8 billion, as of September 30, 2016) was less than 5% of its market value on the same date ($396.9 billion). This is because Amazon is a high-growth company that has significant intangible assets not currently listed on its balance sheet. However, asset-intensive KeyCorp’s (KEY) most recently reported book value ($15.2 billion, as of December 31, 2016) was only 23% lower than its $19.7 billion market value on the same date.
At the end of the day, for business transactions, estate planning transfers, or various other purposes, it is unwise and perhaps inappropriate to rely on BVE in lieu of a formal valuation opinion that determines fair market value.
Article written by:
Joseph Borowski, CFA
Director, Valuation Services