If a company files bankruptcy, it must typically liquidate its assets to pay as many of its debtors as possible. However, common shareholders are the usually the last to receive payment. To determine the likelihood of receiving payment during liquidation, common shareholders can calculate the company's book value per share of common stock.
About Book Value
A company's book value, or equity of assets, is equal to the total of the company's assets minus the total of its liabilities and preferred stock. This value represents the funds the company would have available to pay to common shareholders in bankruptcy. The company will also list its book value on its balance sheets. A company's book value is typically lower than its market value, which is based on the price of its shares.
Book Value Per Share
The book value per share is the book value of the company divided by the number of outstanding shares of common stock. An investor can use this value to determine the amount of his investment that he can recover if the company were to file bankruptcy. Some potential investors can also track a company's book value to determine if the company is a good investment. An increasing book value typically indicates that the company is doing well.
A company with $5 million worth of assets, $1 million in liabilities and $500,000 in outstanding preferred shares would have a book value of $3.5 million [5,000,000 - (1,000,000 + 500,000) = 3,500,000]. If the company has 500,000 outstanding common shares, its book value per share is $7 [3,500,000/500,000 = 7]. In this situation, an investor holding common shares of the company can reasonably expect to receive $7 per share if the company fails.
Some investors consider the book value per share to be a poor representation of the worth of a company because the book value doesn't account for growth potential. Such investors typically pay attention to the market value of the shares instead. However, if the company's market value per share falls below the book value per share, investors might consider the company undervalued, which indicates that the shares could be a good investment.
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