Book value and intrinsic value are two ways to measure a company’s value. There are a number of differences between them, but essentially, book value is a measure of the present, while intrinsic value takes estimates into the future.
What is book value?
Book value is based on the value of total assets minus the value of total liabilities – it attempts to measure the net worth a company has built to date. In theory, this is the amount that shareholders would receive if the company went into full liquidation.
For example, if a company has $23.2 billion in assets and $19.3 billion in liabilities, the company’s book value would be the difference of $3.9 billion. To express this number as book value per share, simply take book value and divide it by the number of shares outstanding. When a particular company is currently trading below book value, it is often considered undervalued.
However, there are several problems with using book value as a measure of value. For example, it would be unlikely that the value the company would receive in liquidation would match book value per share. Nonetheless, it can still be used as a useful benchmark to gauge how much a profitable company’s stock might fall if the market turns sour.
What is intrinsic value?
Intrinsic value is a measure of value based on the future returns a company is likely to generate for its investors – it attempts to measure the total net worth that a company is likely to build in the future. It is considered the true value of the company from an investment perspective and is calculated by taking the present value of the profits (attributable to investors) that a company is expected to generate in the future, together with the company’s future sales value.
The idea behind this measure is that buying a share entitles the owner to a share of the company’s future profits. When all future earnings are accurately known along with the final sale price, the true value of the business can be calculated.
For example, if we assume that a company exists for a year and makes $1,000 before it sells for $10,000, we can determine the company’s intrinsic value. At the end of the year we will have received $11,000. If our required rate of return is 10 percent, then the present value of future earnings and selling price is $10,000. If we paid more than $10,000 for the company, our required rate of return would not be achieved.