Forum Archive Index - June 2003

["Gavin Treadgold" <gav@rediguana.co.nz>]

Hi All.

> -----Original Message-----
> Book value is the the accounting value of assets.  For example you buy a
> nice Mercedes, you have an asset.  But the book value of the
> asset decreases over time as deprecation sets in.

This is true for the book value of an individual asset, but from an
investment perspective I believe that to calculate the total book value of a
company you must offset any liabilities against the assets to generate the
book value. Perhaps a good indicator of the book value of a company is how
much cash would be generated if the whole company was liquidated and sold.
Before distributing the cash, all the debts must be paid off and then the
remainder is paid out - this final amount for payment is what I would call
the book value.

Book value is pretty much a snapshot of the current point in time, it does
not take into account future earnings.

Market capitalisation, the markets value of the company, on the other hand
is a speculative value of the current book value _plus_ future earning
potential. If a company is expected to generate good growth (and hence
earnings) in the future, then investors are prepared to pay a premium for
the future earnings and the market cap will be greater than the book value
of the company. As market cap is number of shares * share price, the Price
to Earnings ratio (P/E) is one indicator of the current premium that the
market has on future earnings for the company. The higher the P/E, the more
growth in earnings is expected by the market and the higher premium an
investor will pay for partial ownership of the company.

I guess a basic summary is: -
 * book value is how much cash would be generated if all the assets were
sold for a fair price and outstanding debts being paid off
 * market value is the markets current valuation of the business, which
incorporates both book value, and speculation on future earning potential.

Hope this helps!

Cheers Gav


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