Keys to calculating net book value and assessing if a stock is undervalued

Why Is Understanding Book Value Important?

When investing in the stock market, investors face an uncomfortable question: Is this stock really expensive or is there a hidden bargain? To answer, we need to understand a fundamental concept that many overlook: the book value of the shares.

When analyzing a listed company, it’s not enough to look at the price displayed on the screen. Behind each share, there is a real equity, a sum of assets minus liabilities belonging to each holder. That is precisely the book value: the accounting representation of shareholders’ equity divided by the number of shares outstanding.

The key difference from the nominal value is that the nominal only matters at the time of share issuance, while the book value evolves constantly according to the company’s current financial situation. That’s why experienced investors also call it “book value,” an essential term in value investing strategy, which aims precisely to detect discrepancies between what a company is truly worth (according to its accounting books) and what the market is willing to pay for it.

The Gap Between Market Price and Book Value

Here lies the crux of the matter. The market price not only reflects the company’s assets but also expectations, investor sentiment, and sector trends. While the book value is static and calculated from hard data, the price is dynamic and subjective.

It’s common to encounter situations where a stock trades at €34 but its book value is barely €15. This happens when investors have high hopes for the company’s future. But the opposite also occurs: stocks trading below their book value, which can indicate an opportunity or a market warning.

How to Calculate Book Value Per Share

The calculation is straightforward. Listed companies are required to publish their quarterly and annual balance sheets. To obtain the book value, subtract liabilities (debts) from total assets (properties and rights):

Book value = Assets – Liabilities

Then, to find out how much corresponds to each individual share, divide this result by the number of shares outstanding:

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

Let’s consider a concrete example. If a company has assets worth €3,200 million, liabilities of €620 million, and 12 million shares outstanding:

(3,200,000,000 – 620,000,000) / 12,000,000 = €215 per share

The P/B Ratio: Your Tool to Detect Overvaluation

Once you know how to calculate book value, you can use a powerful metric: the Price-to-Book ratio, abbreviated as P/B. It is obtained by dividing the current market price by the book value per share.

P/B = Market Price / Book value per share

A result greater than 1 means you are paying more than what the company is worth on its books (possible overvaluation). A ratio below 1 suggests the stock is trading below its book value (possible undervaluation).

Let’s take two cases:

• Company ABC: P/B = 84 / 26 = 3.23 (very expensive)
• Company XYZ: P/B = 27 / 31 = 0.87 (cheap)

These calculations form the basis of analysis found on specialized financial websites, where you can quickly see if a stock is bullish or bearish based on its accounting fundamentals.

The Role of Intangible Assets: An Important Blind Spot

Here’s the problem. Book value only accounts for tangible assets: buildings, machinery, equipment. It completely ignores intangibles: brand, patents, software, corporate talent.

This is particularly problematic with tech or software companies. Creating a program may cost little (programmer salaries, equipment), but its market value can be astronomical. That’s why you’ll see that the P/B of tech firms is usually much higher than that of industrial companies. It doesn’t necessarily mean they are overvalued; simply, the metric doesn’t capture their true value.

Amortization and Depreciation: Necessary Adjustments

When evaluating specific assets (machines, vehicles, infrastructure), we must consider amortization or depreciation. It represents the progressive loss of value that an asset suffers due to use and the passage of time. This factor should be included when calculating the book value of individual assets in corporate accounting.

The Limitations of the Method: Cases Demonstrating Its Flaws

Book value has legitimate criticisms. Small companies (small caps) generally have book values far from their market quotes because they were created recently and grow on future promises, not current assets.

Additionally, there is the phenomenon of “creative accounting.” Some accountants apply legal but questionable techniques that end up overvaluing assets and undervaluing liabilities, distorting results. A company can present seemingly healthy accounts when its reality is very different.

The most notable case in Spain was Bankia. In 2011, it went public with a 60% discount to its book value. The premise seemed irresistible: a huge bargain. However, a few years later, the entity went bankrupt and was absorbed by CaixaBank in 2021. Book value does not predict the future.

Value Investing: When Book Value Is Your Compass

The value investing strategy is based precisely on the concept we just outlined. It seeks companies where there is a gap between the book value and the market price, betting that eventually the market will recognize the true value of the company.

However, finding a P/B below 1 does not guarantee profits. There are “cheap” stocks that have been deteriorating for years. The stock market moves on expectations, and if the global economic context is adverse for the sector, the price will never reflect the book value.

Fundamental Analysis: Where Book Value Fits Perfectly

Fundamental analysis builds its conclusions on real company data: balance sheets, results, macroeconomic conditions, sector prospects, management. Book value is a central piece of this puzzle, not the complete solution.

Technical analysis, on the other hand, ignores these fundamentals and only studies historical price patterns. Both methods have their supporters and critics, but it is fundamental analysis that fully leverages the concept of book value.

Practical Applications in Investment Decisions

Calculating book value is especially useful when comparing two investment candidates and you need to assess which has a stronger balance sheet. It’s not a reason to buy automatically, but it is a differentiating factor when you’re at a crossroads.

Knowing the P/B allows you to objectify how expensive or cheap a stock is relative to its actual assets. This data, combined with other indicators (return, earnings growth, competitive position), gives you a more complete view of the business.

Conclusion: A Useful but Not Definitive Tool

Book value is valuable information but with clear limitations. It reflects past and current accounting, not future potential. Intangibles are outside the equation. The quality of data depends on the integrity of the accountant.

As an investor, you should use this metric as a support for your decisions, not as the decisive criterion. True opportunities only appear when you combine rigorous accounting analysis with a deep understanding of the business, its competitive advantage, and the global economic context. Book value opens the door; comprehensive analysis leads to success.