How to identify if a stock is expensive or cheap: a practical guide to net book value

When you invest in stocks, you have probably wondered at some point if you are really paying a fair price. The answer lies in understanding what book value is and how to use it to spot investment opportunities. This concept, also known as “book value,” is the tool that distinguishes investors who make money from those who simply buy aimlessly.

The shortcut to know if you’re buying expensive or cheap

Imagine you find two stocks: one trades at €84 and the other at €27. Which one is cheaper? Without knowing their book value, it’s impossible to tell. The reason is that book value represents what the company is truly worth according to its balance sheets: its assets minus its debts, divided by the number of shares outstanding.

The key tool used by professionals for this is the Price/Book Ratio (P/VC). It works like this: if the result is greater than 1, the stock is expensive relative to what is shown on the books. If it is less than 1, it is cheap. Let’s take a real example: Acerinox, the Spanish steel company, has historically shown a low P/VC, suggesting that the market undervalued it. Conversely, Cellnex, another Spanish company, often trades with a high P/VC, indicating relative overvaluation.

What exactly is book value

Behind these numbers is a simple logic: book value is the difference between everything a company owns (s tangible assets) and everything it owes (s liabilities). When you divide this by the number of shares outstanding, you get the book value per share.

Basic formula: Book value per share = (Assets – Liabilities) / Number of shares

Suppose the company “ABC” has €3,200 million in assets, €620 million in debts, and 12 million shares outstanding. The calculation would be: (3,200 - 620) / 12 = €215 per share. This number is the intrinsic value each share contains according to the accounting records.

Why some call it “value in books”

The term comes from the fact that accountants record these data in the company’s books. Value investors specifically look for companies whose market price is below their book value, betting that eventually the market will correct the price and recognize the true value of the business.

The key difference with nominal value is that nominal value is calculated at the time of share issuance, while book value changes constantly as the company earns profits or losses, reflecting the current circumstances of the business.

The risks of relying too much on this

The case of Bankia is the most stark example: in 2011, it went public with a 60% discount to its book value, which seemed like a historic bargain. However, its performance was catastrophic, leading to its liquidation and absorption by Caixabank in 2021. What went wrong? Book value does not capture hidden risks or the actual quality of assets.

Another important limitation: book value ignores intangible assets. For a software or biotech company, this is a huge problem. The cost of developing a program is low in accounting terms, but its real value is exponentially higher. That’s why you will see that tech companies typically have much higher P/VC ratios than industrials.

There is also the issue of “creative accounting”: although legal, some accountants may inflate assets or minimize liabilities, distorting the numbers. And in small caps (small caps), book value is almost useless because these are growing businesses where the promised future value is completely different from the current book value.

How to use it without fooling yourself

Book value works best within fundamental analysis: in-depth study of balance sheets, macroeconomic conditions, competitive position, and future prospects of the company. It is not an automatic buy signal, but a piece of data that complements your research.

When considering investing in a stock, look at its P/VC. If it is below 1, it is promising, but then investigate: why does the market underestimate it? Are there risks no one sees? Is the sector going through a crisis? True opportunities arise when you combine an attractive P/VC with solid analysis of the business and its competitive advantages.

Book value is your compass, not your complete map. Use it as support in your decisions, never as the main reason to buy or sell.