Book value, market capitalization and enterprise value

Which observable measures hint at intrinsic value?

Three numbers you can look up: book value of equity (from the financial statements), market capitalization (from the share price) and enterprise value (EV) (from the market values of all claims, net of cash). None is intrinsic value, but each gives a clue.

What you can look upnone is intrinsic value, each is a clue

• Book value of equity Memorize assets minus liabilities in the audited accounts; historical
• Market capitalization Memorize price times shares outstanding; forward-looking
• Enterprise value Memorize equity plus preferred plus net debt; the whole firm to a buyer

What is book value of equity, and what distorts it?

Book value of equity (BVE) is the difference between the carrying values of assets and liabilities in the audited statements.

$$BVE_t = \text{Book value of assets}_t - \text{Book value of liabilities}_t$$

For a single share, analysts use book value per share . Shareholders’ equity includes closely held shares but excludes minority interest (also called non-controlling interest), a stake with little say over the company.

$$\left(\frac{BVE}{\text{Share}}\right)_t = \left(\frac{\text{Shareholders' equity}}{\text{Shares outstanding}}\right)_t$$

Shareholders’ equity is built up like this (the shareholders’ equity components ):

$$\text{Shareholders' equity} = \text{Share capital} + \text{Additional paid-in capital} + \text{Retained earnings} - \text{Treasury stock}$$

Book value is a historical accounting figure, and several things distort it.

• Historical cost and depreciation. Assets may sit at old costs. Newer assets are less depreciated and carry higher values than older ones, so firms with different asset ages are hard to compare.
• Intangibles. Internally generated intangible assets such as a brand built in-house are usually expensed, while bought ones are amortized (finite life) or tested for impairment (indefinite life). Goodwill , the part of an acquisition price above the fair value of the identifiable net assets, also sits in assets. So an acquisitive firm can show more assets than its cash-generating capacity justifies compared with a firm that grew organically. Analysts therefore usually exclude intangible assets, including goodwill, when they calculate book value.
• Liabilities at face value may miss contingent liabilities such as product liability, environmental or legal claims.
• Write-downs cut book value suddenly when assets lose value.

Book value helps most for firms with large tangible assets and similar asset structures. It says little about asset-light or early-stage firms, whose balance sheets do not show future earning power.

Negative book value of equity can signal a higher risk of financial distress, but not always. Fast-growing firms or firms that wrote down assets can still create value. A profitable firm can also reach negative book equity by paying out more in dividends and buybacks than it earns, while its valuable brand stays off the balance sheet. With negative book value, the price-to-book ratio is meaningless.

Book value of equitya historical accounting figure

• Historical cost and depreciation asset age changes carrying values
• Intangibles and goodwill inconsistent recording; analysts usually exclude them
• Contingent liabilities legal, environmental or product claims missing
• Write-downs sudden drops
• Payouts above earnings can make book value negative at a profitable firm

What does market capitalization add?

Book value looks back. The share price looks forward, reflecting expected cash flows from profitable (positive net present value) investments. Market capitalization changes every trading day, while book value changes only when statements are published.

$$\text{Market capitalization}_t = P_t \times \text{Shares outstanding}_t$$

Shares outstanding include shares held privately or by management, such as restricted stock, as well as freely traded ones. The count changes with issues and buybacks and is known only when filings come out.

For Ostra, a price of EUR 22.00 times 50 million shares gives a market capitalization of EUR 1,100 million.

Share repurchase effects show up in book value first. If Ostra buys back 2 million shares at EUR 22.00 on the last day of its year, book equity falls by the cash paid, 2 × 22.00 = EUR 44 million (680 → 636). Buying at the market price should not by itself move the price. Any change comes from what the buyback signals: managers think the shares are cheap, or the firm lacks investment ideas. Outsiders learn the new share count only when it is disclosed, unlike a dividend, whose ex-dividend price drop is visible at once (dividends, splits and repurchases).

Market value above or below book value

When investors value the firm’s assets above their carrying amounts, market capitalization exceeds book equity. Comparing the two shows excess value and value shortfall . An “excess” (market above book) is usually read as the firm creating value for its owners, if book value is not distorted. A “shortfall” (market below book) implies that the assets, sold one by one at book value, would fetch more than the business is worth as a going concern.

A share below book value may be undervalued, but it can be fairly valued or even overvalued if the firm is uncompetitive, its assets are obsolete or its managers are weak. A firm far behind its peers may slide toward distress, where creditors may force a liquidation and shareholders can lose everything.

The price-to-book (P/B) ratio compares the two.

$$\left(\frac{P}{B}\right)_t = \left(\frac{P}{BVE/\text{Share}}\right)_t$$

Ostra’s P/B is 22.00 ÷ 13.60 = 1.62 on reported book value, and 22.00 ÷ 8.80 = 2.50 excluding intangibles.

Ratios like P/B are multiples . Among similar firms, a lower multiple makes the price look more attractive, on the assumption that it will move toward its peers’. A higher P/B means investors value future cash generation more relative to existing net assets. Comparing a company’s multiples with similar companies is the method of comparables . Lesson 2 of this module gave the price-to-earnings (P/E) ratio and the composite (peer average) rule, and Learning Module 7 goes deeper.

Check leverage before you compare. Ostra’s assets are 1,840 ÷ 680 = 2.7 times its book equity and its P/B is 1.62. Its peer Brenna Aggregates has assets about 2.6 times book equity and a P/B of 1.30, so Brenna looks cheaper on this measure. A third firm, Calder Cement, has a P/B of 0.90 but assets 9 times its book equity: so much more debt that its P/B cannot be compared with the other two. Use P/B only among firms with similar reliance on debt and no large book distortions.

What is enterprise value?

Enterprise value is the value of the whole firm from a buyer’s point of view. A buyer takes on the debt but also gets the cash, which can pay part of the price or repay debt, so only net debt (debt minus cash and cash-like investments) counts. EV = market value of equity + preferred shares + net debt.

$$EV = \text{Market value of debt} + \text{Market value of equity} + \text{Market value of preferred shares} - \text{Cash and short-term investments}$$

Questions can run the formula backward. The market value of equity is EV − debt − preferred + cash, so 1,550 − 520 − 60 + 130 = 1,100. With no preferred shares, net debt = EV − market capitalization.

EV helps because it includes the claims of lenders, preferred and common shareholders, so it compares firms with different reliance on debt better than the share price does. It is stated in the reporting currency, so translate enterprise values into one currency before comparing them. In practice the market value of debt is often not observable, so analysts use par or book value; debt far from par is valued from quotes on similar bonds (same maturity, sector and credit quality).

Exam tip Cash is subtracted, not added: a buyer gets it back.

Enterprise value multiples

An EV multiple divides enterprise value by a measure available to all capital providers: revenue, earnings before interest, taxes, depreciation, and amortization (EBITDA) or operating profit.

$$\text{EV multiple} = \frac{\text{Enterprise value}}{\text{Revenue or an operating profit measure}}$$

Book value, market capitalization or enterprise value?

	Book value of equity	Market capitalization	Enterprise value
What it measures	Net assets in the accounts	Market value of the equity	Value of the whole firm to a buyer
Time view	Historical	Forward-looking	Forward-looking
How often it changes	At each reporting date	Every trading day	Every trading day (debt values less often)
Best for	Firms with large tangible assets and similar asset structures	Valuing the shares	Comparing firms with different debt; relating value to operating profit
Watch out	Historical cost, intangibles and goodwill, contingent liabilities, write-downs, negative values	Share count known only after filings	Market value of debt may need estimating; reporting currency