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Ask a Fool: What Is Book Value and Why Is It Important to Investors?

By Matthew Frankel, CFP® – Dec 7, 2018 at 12:00PM

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This accounting metric can be useful to investors, but only in certain cases.

Q: What does "book value" mean, and why is it useful to me as an investor?

Book value is one of the simplest investing metrics to calculate. Look at a company's balance sheet and subtract the company's total liabilities from its total assets. To calculate book value per share, divide this figure by the number of shares outstanding.

A good way to visualize book value is if a company decided to close its doors, sell all of its assets, and pay off all of its liabilities, book value is (theoretically) what investors would be left with.

A similar metric is tangible book value, which is the same calculation but excluding intangible assets such as intellectual property and goodwill.

From an investor's perspective, book value is most useful for finding attractive value stocks, and for comparing the valuations of similar companies. As a current example, investment banking giant Goldman Sachs is near the top of my watchlist, partially because it trades for 5% less than its tangible book value, one of the cheapest valuations in the banking industry.

On the other hand, book value is not very useful when it comes to valuing growth stocks, as they tend to primarily trade based on their future profit-generating potential, not the current value of the business's assets. Just to name a couple of growth stocks I follow, Square and Amazon trade for roughly 23 and 21 times their respective book values.

Finally, like any other metric, book value is most useful as part of a well-rounded analysis, not as a stand-alone metric.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Matthew Frankel, CFP owns shares of SQ. The Motley Fool owns shares of and recommends AMZN and SQ. The Motley Fool has the following options: short January 2019 $80 calls on SQ. The Motley Fool has a disclosure policy.

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