Market Price & Book Value (Price Vs Value)

Current Market Price (CMP) and Book value plays a major role in purchasing any business in stock market. Current market price is the price at which the stock is trading currently. Any investor should pay this price to buy the business. In my opinion, there is another way of looking at the stock through Book value 

Let's compare this with buying a brand new car. When we look at the newly launched brand new car in the showroom and ask for the price, that's exactly the Current Market Price of the car. We need to pay that price to own that car and drive home. Similarly any stock behaves that way. On the other hand, when we dismantle that car into pieces and sell all the spare parts completely. Will we get the same price of the brand new car displayed in the showroom ? 

I believe we wont get the same price of the brand new car when we dismantle and sell it. There may be many reason to it. Few may be Assembling cost, Depreciation value and so on. But the exact value of the car is the Spare parts + Assembling cost + Labor cost + Profit percentage involved. This is exactly the book value of that car

Think if the new car price is Rs.30 lakhs and the book value calculated as described above is around Rs.15 lakhs. Then the P/B ratio (CMP / Book Value) is 30 lakhs / 15 lakhs = 2. Will we consider to buy that car ? Probably sometimes yes. Let's imagine if the book value is Rs.5 lakhs. Then the P/B ratio is 6. Will we consider to buy that car now ? One should definitely not buy that

On the other hand, if the CMP of the car is Rs.30 lakhs and the Book value is Rs.32 lakhs. Then the P/B ratio is 0.93. This means the car / business / stock is undervalued. In most cases, people do not look the book value of the business. They buy the business which has very high P/B ratio. Normally, if the P/B ratio is around 1.5, then we can consider that as a great business (my point of view)

Similarly, if we buy a car worth of Rs.30 lakhs and in next 2 years, the depreciation should be considered in valuating the price of the car. So the book value of the car is Buy price - Depreciated value of the car

In financial terms, book value is companies equity value as defined in financial statements of the company. Book value represents the fair and accurate picture of the company's worth

I would recommend any investors to consider this book value before buying any business. Most people look only the Current market price and they come to a decision. One should understand the sector and individual company business very well to calculate the book value.

Have a Great Day

B G Nareshkumar