‘MAGIC NUMBER’ 02 PRICE / BOOK VALUE The Definition This ratio is often called by the shorthand term ‘price to book’. It is the share price divided by the book value of the shares. Book value is the value of the net assets attributable to shareholders expressed as a per share figure. The Formula P/BV = Share price / (stockholders equity / no. of shares in issue) The Components Share (stock) price – the current market price of the shares, normally the mid-market price at the close of business on the previous trading day. Book value – this goes by a number of different names, including stockholders or shareholders’ equity, shareholders funds, net assets, and net tangible assets. Take the figure that represents the tangible fixed assets of the business plus its current assets, and then deduct all current liabilities, long-term creditors and provisions. The residual is the assets that are ‘owned’ by shareholders. Issued shares (common stock) outstanding – shares that have been issued and are capable of being publicly traded. Use the shares outstanding at the point in time the calculation is performed for the calculation. You can get these numbers from the annual report but they need to be adjusted for any subsequent share issue or stock split. Where’s the data? Share (stock) price – from any daily newspaper or financial web site. Take note of the units in which the share price is expressed. In the UK, shares are traditionally quoted in pence, so to arrive at a market capitalisation expressed in pounds the price must be adjusted accordingly when you do the calculation. Book value – this is on the face of the consolidated balance sheet normally using one of the alternative phrases listed earlier. You can also identify it as the total of share capital and reserves. Take care to exclude, if they are present, any intangible assets or goodwill. Intangible assets should only be included if they have been developed by and are integral to the business. Examples where this is appropriate include customer lists, publishing titles, copyright on intellectual property like software, and some popular consumer brand names. Issued shares outstanding – these are in the notes to the accounts. You can find the note from a reference in the consolidated balance sheet next to the heading ‘called up share capital’ or similar term. Use the number of ordinary shares at the end of the year, and not their stated nominal money value.
The number of shares used to calculate earnings per share should not be used. This will normally be an average for the year, not the most recent year-end figure. In this instance, the most recent figure is the one to use. Calculating it– the theory The table shows the different numbers to be pulled from the accounts and how to use them to calculate the ratio. (fig2.1) Calculating it for Sony The table shows how the highlighted numbers from this extract from the accounts of Sony for the year to March 2002 combine to produce the ‘magic number’. Sony is a major global consumer electronics group and a film, software and music publisher. More information on the company is at www.sony.com. For simplicity I have taken the numbers stated in the accounts in US dollars, as this avoids the large unwieldy numbers generated when using Japanese yen in the calculation. (fig2.2) Sony’s accounts provide a neat illustration of some of the issues involved in calculating meaningful book value. In particular Sony has significant intangibles and goodwill in its accounts. These relate to brand names, software titles, film and music back catalogues, and recording contracts. Many of these have real value. However the example shows two calculations for book value, one excluding intangibles and goodwill, and one including these items. What it means Opinions differ about how to calculate book value. Most definitions exclude minority interests (the proportion of assets in partly owned subsidiaries that is owned by outside shareholders), and goodwill. Another issue related to definition is how to treat the value placed on property assets and listed and unlisted investments. The most common convention is that long term property assets can be included on the basis of an annual revaluation, that listed investments can be included at cost or market value and unlisted investments can be included at cost. These distinctions become important when using ‘price to book’ as a tool for comparing different companies. In Sony’s case, as explained above, intangibles are a significant element. They do not simply reflect the goodwill generated by an acquisitive company, but that of company that has brand names, intellectual property rights and contracts of real worth. So it is legitimate to include them as assets. While ‘price to book’ is a widely used quick yardstick it needs interpreting with care, and not just because of the quirks of calculation explained above. The more serious objection to it is that, while it works well for companies that are rich in tangible
assets, it is less meaningful for those that have substantial elements of goodwill in their balance sheets. Arguably what matters more is not where the share price stands in relation to assets, but the profits that management generates from the assets at its disposal. Return on assets is much more relevant to the long-term value of a company as an investment. We return to this theme later in ‘Magic Numbers’ 7 and 24.