Understanding Book Value (Net Tangible Assets) on a Balance Sheet
To find a company's book value, also known as its net tangible assets (NTA), you subtract the value of all liabilities and intangible assets from its total assets. This leaves you with the theoretical value of all of the company's tangible assets, which are those assets that can be seen and touched, as opposed to things such as patents, trademarks, copyrights, brand reputation, and customer relationships.
Why Net Tangible Assets Are Important
The amount of NTA a publicly traded company has on its balance sheet—its book value—can be used by investors to help determine whether the company's stock is worth purchasing at its current price. A company with lots of tangible assets will also be looked at more favorably by lenders and so should be able to borrow at lower rates.
NTA are more important in valuing some types of companies than others. For example, real estate investment trusts and manufacturers of various products have lots of NTA, and intangible assets are generally of lesser importance. Some technology companies, such as those that make software or provide internet-related services, have fewer tangible assets and so NTA aren't as good of an indicator of the companies' true value.
Calculating NTA per Share
A company's NTA per share is calculated so it can be fairly compared with its share price. The NTA per share, or book value per share, is simply the NTA divided by the number of shares the company has outstanding. Let's suppose a company's NTA total $36 million, and the company has 1 million shares outstanding. That makes its NTA per share $36.
If the stock of a company whose intangible assets aren't of great importance to the company's bottom line is trading below $36, investors might conclude it's a bargain. If it's trading exactly at $36, they might view it as fairly valued. If it's trading at more than $36, investors would probably avoid the stock because it appears to be overvalued.
Comparing Price-to-Book Ratios
A metric called the price-to-book ratio (P/B) can be useful for making comparisons between the stocks of companies in the same industry, even if it's not an area of business in which a lot of tangible assets are required.
The P/B is the share price of a company divided by its NTA per share, or book value per share. If the ratio is less than 1, the stock is trading at a discount to its book value. If the ratio is greater than 1, the stock is trading at a premium to its book value.
Companies without a lot of NTA tend to trade at multiples of their P/B. When screening for stocks to purchase, it may be helpful to compare the P/Bs of low-NTA companies within the same industry. Those with smaller P/Bs may be better buys than their rivals, though investors should also consider other valuation methods such as return on equity and the price-to-earnings ratio.
Calculating Individual Book Values and Depreciation
The book value of an individual tangible asset is calculated by subtracting accumulated depreciation from the initial cost of the asset, or its purchase price. The value of tangible assets decrease over time. For instance, a truck with 100,000 miles on it isn't as valuable as a brand-new one. The amount the asset has declined in value over time is the depreciation.
The amount of depreciation to put in the company's books every year can be calculated by first subtracting the scrap or salvage value of an asset from its purchase price. That depreciable cost is then divided by the number of years of useful life the company can reasonably get out of the asset. The IRS provides guidelines on the number of years various types of assets should be depreciated over. For example, all vehicles are depreciated over five years.
Let's say the truck cost $45,000 and its scrap value is $5,000. The depreciable cost is $40,000, and the depreciation each year would be one-fifth that, or $8,000. So in the third year, the accumulated depreciation on the truck would be $24,000, and its book value would be $21,000.
Internal Revenue Service. "Property and Equipment Accounting," Section 220.127.116.11. Accessed Jan. 24, 2020.