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Book Value

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Hi All!

Good Afternoon!

In our recent classes we had an Introduction to Financial Ratios used in Stock Analysis.

In yesterdays class, we continued our discussion on PE Ratio.

We took the PE of SBI and compared it with the industry PE and made appropriate observations.

Similar to equity shares, Nifty and Sensex also has a PE ratio as well.

We observed PE bands and observed that since Nifty is over 19 at the moment, it is expensive.

When investing in a stock, we need to keep a watch on:

1. Stock PE

2. Industry PE and

3. Nifty PE

Several of our friends asked queries in regard to Stock PE and Industry PE

What to do when:

If the stock PE is lesser or more then industry PE but equal to Nifty PE ?

Our primary comparison will be between Stock PE and Industry PE only.

Nifty PE talks about the overall trend of the market.

So, we need to decide if the stock will go up or come down going forward by comparing with Stock PE with Industry PE

What to do when: If industry PE is more than Nifty PE.

If industry PE is more than Nifty PE it means that the industry is performing extremly well.

There is no correlation that we wish to draw between the two.

Dhiraj asked:

Let say yes bank hav pe 100 ,industry hav pe 50 ,does it mean downfall is possible in yes bank ya yes bank is gng to perform even better n one can buy it ???

When the stock PE is exceedingly high compared to the industry, there are two things that could happen:

1. The stock price would come down.

2. The industry will try to catchup and all stocks of the industry will go up.

We can determine this by observing industrial trends.

Sir: bhel pe is -41 ?

A stock PE will be negative if it is loss making.

Can v compare sector pe wid nifty pe nd decide trend of sector?

Very Good Question:

The correlation between Sector and Nifty is weak. It can be one of the several deciding factors but cannot be an final answer.

I will explain about identification of sectoral trends when we discuss about thematic and sectoral indicies later.

But bhel is navratna company n all others parameters r good then?

Loss maker is a loss maker. Who knows it can become an LML.

I am not commenting on the stock but it will be better to skip a stop and go reach out for a better one with no defects at all.

Yesterday, we saw that Nifty PE is in expensive zone.

It doesnt make sense to invest in an expensive market.

But then again we do not want to miss being invested in the market.

Since we will be in the market in all times, we have two methods of investing.

1. Continue to invest the same old way using cost averaging.

2. Reduce the daily investment budget

We then made a small modification to our cost averaging method to include the Nifty PE factor.

  • Rule #12: Keep an eye on Nifty PE when investing.*

Because every stock has some weight-age in Nifty, stock moments impact Nifty and there by Nifty PE to that extent.

Understood till here?

The next topic is *Book Value*

Every company,

during its course of business activities,

builds one form or the other assets.

So, when the company is closed, wound-off and sold off (liquidated),

its assets will be liquidated and the money thus accrued will be given to share holders.

After all, the shareholders are part owners of the company.

What is the money that the company receives upon liquidation?

The *Book Value* tell us that.

When the company is about to get liquidated,

the amount that will be left in his hands of the company

after selling all its assets

and settling all its creditors

is the *Book value*

  • Book value* is express as 'per share' basis.

Suppose the book value of a company is Rs. 1000 Crs,

then this is the amount of money the company can expect to receive after it sells everything and settles its debts.

For example, if the *book value per share* is Rs. 50,

then Rs. 50 per share is what the shareholder can expect in case the company decides to liquidate.

There is a formula for computing BV.

BV = [Share Capital + Reserves / Total Number of shares]

Now, let us see a detailed definition of Book Value

Book value is based on the original cost of the asset less any depreciation, amortization or impairment costs made against the asset. Traditionally, a company's book value is its total assets minus intangible assets and liabilities.

Generally the BV is determined yearly because the full length accounting data of the company is released at the time of Annual results. Balance Sheet etc

Let us take a practical example to understand.

Assume that, from the balance sheet of the company, we got the following data:

Share Capital = Rs.50.6 Crs

Reserves = Rs. 4260.6 Crs

Revaluation Reserves = 0

Number of shares: 75.25 Cr

Hence the Book Value per share = [50.6 + 4260.6 – 0] / 75.25

= Rs.57.29 per share

So when this company gets liquidated and all its debt is paid, each share holder would get Rs.57.29 per share.

So fundamentally speaking, and keeping aside several other factors, it is cheaper to buy Tanla type company than to set up a similar one.

The cheaper the CMP comes down, the more lucrative the investment in the company becomes.

BV alone cannot be of much use. But, when used with CMP, it becomes sme useful information.

  • Price / Book Value* is what we are looking for.

Assume the Stock price of XYZ = Rs. 600 per share

We got BV = Rs.57.29 per share

So P/BV = 600 / 57.29 = 10.4

i.e 10.4x or 10.4 times.

The P/BV tells us how many times the stock is trading over and above the book value of the firm.

This means, we are paying 10.4x times over the value of the company to buy its share.

A high ratio could indicate the firm is overvalued relative to the equity / book value of the company.

A low ratio could indicate the company is undervalued relative to the equity / book value of the company.

If the ratio is less than one, it means, that the company is not running up to par. This, along with other factors, could also lead to a hostile takeover.

The correct (or good number) for P/BV varies from industry to industry.

Generally, Industries and factory units require more infrastructure capital. So their P/B ratios much lower compared to others.

But remember,

P/BV ratios do not directly provide any information on the ability of the firm to generate profits or cash for shareholders.

Now, use the P/BV ratio to compare two similar companies.

This tells us which company is cheap in terms of share price over other

  • Rule #13: Use P/BV to compare companies*

Understood ?

  • Assignment Alert*

Yesterday, you have taken private banks sector and identified PEs

Now add one more factor to it. Find their P/BV.

Now see if the factor can help you decide if a share is a better one or not.

Where can we get P/BV in the moneycontrol app ?

Most apps provide it. No need to worry even if they dont provide. BV will be given everywhere. Price is CMP. So u might have to compute.

How often is book value updated?

It is mostly updated once a quarter or when the company is valued.

Most websites might show it on a yearly-basis because it is at that time that the full scale of financial information will be released in the form of Balance Sheets in Annual Reports.

Important: Book Value is called *Net Asset Value* in the UK

Please throw some practical view about Book value, when it's very low and very high

When it's moderate at time we can easily judge. value of Maruti as per consolidated balance sheet is 920 or like that. ...its a large cap company now it's cmp is about its just running 6 times higher thn it's book value. ...whr as a large cap Co if it is running 10 times higher thn it can be added to the portfolio so I think it can go to the lbl of 6/8K. ..plz ask from other experts too...

Book Value will be cheap when the company's assets are low and is in the process of acquiring them. i.e When the company is savings its profits and building assets. When it gets matured, the BV will be at peak.

Book Value can be best be compared with companies from the same sector. So, compare Maruti with Tata Motors and then decide.

Some inputs from our friend Yogi:

A company worth owning should be worth more than its book value. Quite true right? Then why do we find stocks more attractive whose who's BV is less than CMP?

Inexact, But Good.

Remember, valuation is not an exact science. Book value is merely an accounting number, influenced by tax laws and management. Fortunately, book value does not have to perfectly measure the underlying value of a company’s assets to be a highly effective tool for selecting stocks. Rather, it works because a profitable, well-managed concern is effectively using its assets to make money. The desks, the machines, the patents, and even the website address are worth more than their face value because, combined, they can increase shareholder’s net worth. A company worth owning should be worth more than its book value.

BV might not be a good factor in IT industry. p/bv is not significant and not meaningful as the real asset for any IT co is its employees, which does not get captured here.

  • Assignment*

Open MS Excel. List down all your invested stocks. Enter the CMP and BV. Calculate P/BV of each of them. Make some conclusions on them.

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