THERE is a well known idiom, “there are many ways to skin a cat”, and in the case of appraising the true value of a company, there are many methods that can be employed.
The most basic value of a company is its book value – total assets minus liabilities – or the shareholder equity on the balance sheet. In this accounting calculation, assets are valued at their original cost minus depreciation, which is a non-cash expense used to reduce the book value of assets as they are consumed or used up in the process of obtaining revenue.
A more widely used version, tangible book value, deducts intangible assets, or non-hard assets such as goodwill, patents and capitalised start expenses. This is considered a conservative valuation of the company and the best approximation of its value should it be liquidated. In calculating economic book value, the assets are adjusted to their market value, and intangible assets are included. Book value per share is calculated by dividing the balance sheet equity, or book value, by the number of shares outstanding.
Book value is effectively the estimated liquidation value of a company and book value per share is generally viewed as a floor for a stock price. A stock can trade under book value per share, however, because in a worst-case scenario it is what is left over if all the assets were sold and the debts paid.
The price-to-book ratio is a valuation arrived at by dividing the market price of a share with the respective company’s book value per share. It is a metric used by investors to assess what they are paying for the company’s assets. If a company is trading close to a price-to-book ratio of one, it generally means investors believe the company’s assets are overvalued or the company is earning a poor return on its assets.
On the other hand, if the company is trading at a high price-to-book multiple, investors may feel that the company’s assets are undervalued. Book value per share is of less relevance for companies that are driven by intangible assets such as technology and pharmaceutical companies. It is an excellent measurement for asset-driven companies such as banks, auto, telecommunications and insurance companies. Return on assets reflects how profitable a company’s assets are in generating revenue. It is calculated by dividing net income by average assets for the period. Return on assets is useful in comparing companies in the same industries, as it measures how a company turns assets into net income.
Market capitalization is what investors feel the company is worth. It is the market value of the company’s shares. Market capitalization is the share price multiplied by the number of shares in issue. It is a market estimate of a company’s value, based on perceived future prospects, and economic and monetary conditions. Market capitalization differs from book value as it is what investors are willing to pay for the company, rather than the net worth.
Anthony Galliano is the chief executive officer at Cambodian Investment Management.