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Book Value
Book Value and Shareholder
Equity are not quite the same thing. To find a company's book value, you
need to take the shareholders' equity and exclude all intangible items.
This leaves you with the theoretical value of all of the company's tangible
assets (those which can be touched, seen, and felt). For this reason, book
value is sometimes also called "Net Tangible Assets".
Net Tangible
Assets (or Book Value)
The amount of net tangible
assets a company has is particularly important.
Since you should always analyze the balance sheet you get directly from
the company (as opposed to the ones you find on Yahoo or other financial sites),
you may not always have this figure calculated for you. To calculate it,
take the total assets and subtract all of the intangible assets such as
goodwill. What you are left with is the nuts and bolts of the company; the
buildings, computers, telephones, pencils, and office chairs.
In the past, it was generally
thought the more assets a company had the better. Over the past twenty
years, value investors have come to reject this idea in its pure form; it is
actually preferable to own a business that generates earnings on a lower asset
base.
Why? Let's say your
company earns $10 million a year and has $30 million in assets. My company
earns the same $10 million but has $50 million assets. It is generally
understood that a relationship exists between the amount of assets a company has
and the profit it generates for the owners. If you wanted to double the
earnings of your company, you would probably have to invest another $30 million
into the company. After the reinvestment, the business would have $60
million in assets and earn $20 million a year.
On the other hand, if I
wanted to double the earnings of my company, I would have to invest another $50
million into the business (which would double the assets). After the
reinvestment, my business would have $100 million in assets and generate $20
million a year.
What does that mean?
You would have to retain $30
million in earnings to double your profits. I would have to retain $50
million to get the same profit! That means that you could have paid out
the difference (in this case $20 million) as dividends, reinvested it in the
business, paid down debt, or bought back shares! We will talk more
about this in the future.
Next page > Common,
Preferred, and Convertible Shares> <<
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