How Are Book Value and Intrinsic Value Different?
Book value and intrinsic value are two ways to measure the value of a company. There are a number of differences between them, but essentially book value is a measure of the present, while intrinsic value takes into account estimates into the future.
What Is Book Value?
Book value is based on the value of total assets less the value of total liabilities — it attempts to measure the net assets a company has built up until the present time. In theory, this is the amount that the shareholders would receive if the company were to be completely liquidated.
For example, if a company has $23.2 billion in assets and $19.3 billion in liabilities, the book value of the company would be the difference, $3.9 billion. To express this number in terms of book value per share, simply take the book value and divide it by the number of outstanding shares. If a given company is currently trading below its book value, it is often considered to be undervalued.
There are, however, several problems with the use of book value as a measure of value. For example, it would be unlikely that the value the company would receive in liquidation would be equal to the book value per share. Nevertheless, it can still be used as a useful benchmark to estimate how much a profitable company's stock might drop if the market turns sour on it.
What Is Intrinsic Value?
Intrinsic value is a measure of value based on the future earnings a company is expected to generate for its investors — it attempts to measure the total net assets a company is expected to build in the future. It is considered the true value of the company from an investment standpoint and is calculated by taking the present value of the earnings (attributable to investors) that a company is expected to generate in the future, along with the future sale value of the company.
The idea behind this measure is that the purchase of a stock entitles the owner to his or her share of the company's future earnings. If all of the future earnings are accurately known along with the final sale price, the company's true value can be calculated.
For example, if we assume that a company will be around for one year and generate $1,000 before being sold for $10,000, we can find the intrinsic value of the company. 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 today of the future earnings and sale price is $10,000. If we were to pay more than $10,000 for the company, our required rate of return would not be met.