One of Warren Buffett’s favorite topics in his annual shareholder letters is book value per share. He talks about how it is a great indicator of intrinsic value.
As we continue our series on valuing banks and financial institutions we break down another formula. This being the Book Value per Share.
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This is an incredibly easy formula to calculate and all the information that we need is right there on the balance sheet. This makes it easy to find what we need and very easy to calculate.
This is one of the last formulas that we will tackle in regards to valuing a bank. Warren Buffett has said repeatedly that you should value a bank as you would any other stock. I agree with that statement and all the formulas that we have tackled so far can be used for any stock if you wish. However, the ones we have dissected are best suited for valuation of financial institutions.
Over the next couple of weeks, I will begin putting together a guide to help us value a bank from start to finish. Why are we doing this? Because banks and financial institutions are a big part of the market, with over 500 banks to choose from. They can be a great source of reliable dividends, as well as price appreciation.
If you would like to learn more about the book value per share, see below.
Valuing a bank can be challenging and confusing, but it doesn’t have to be. Here’s the deal:
Book Value per Share is one the easiest accounting formulas out there that can help us determine the value of a bank or financial firms equity.
We will walk through this formula and how to find the numbers to plug into the formula, and voila! You will have a number that you can use to help you determine the value of that bank you are interested investing in once you find the right price.
I have said this before but valuing banks should be as straightforward as valuing any other company that you are interested in putting some money into.
There are just some different ratios and formulas that we need to know to help make it easier.
This idea comes straight from Warren Buffett, and if it is good enough for him, it is certainly good enough for me.
We have talked about:
And now we will add Book Value per Share to our toolbox, all of which makes us a better investor.
Why are we discovering ways to invest in banks? Because they are a great avenue for dividends, share appreciation, and they are a great source of retirement income for us.
What is the Book Value per Share?
According to Investopedia:
“Book Value per common share is a measure used by owners of common shares in a firm to determine the level of safety associated with each share after all debts are paid accordingly.
Should the company decide to dissolve, the book value per common share indicates the dollar value remaining for common shareholders after all assets are liquidated, and all debtors are paid.”
Breaking it down, this means that if a bank goes out of business, that would be the amount of money a shareholder would get once the bank liquidates.
Book value per share is an accounting measure based on historical transactions.
Warren Buffett states in every annual Shareholder letter that he writes the book value of Berkshire Hathaway as a way of keeping score.
His thoughts on the importance of book value versus intrinsic value were laid out in his Berkshire 1993 Letter:
“It is important to understand, however, that the two terms – book value and intrinsic business value – have very different meanings. Book value is an accounting concept, recording the accumulated financial input from both contributed capital and retained earnings. Intrinsic business value is an economic concept, estimating future cash output discounted to present value. Book value tells you what has been put in; intrinsic business value estimates what can be taken out.”
Of course, we use book value per share to help us determine the value of those assets in relation to a number of shares outstanding. That value is referred to the net asset value if you remember from the post on return on assets.
The higher the return on assets the better the company, or in our case bank, is at turning those assets into cash.
This formula is also known as book value per common share or book value of equity per share.
- Common share: refers to common shares that you and I buy on the open market of said company. It does not include warrants, preferred shares, retained earnings, or treasury stock.
- Equity: this refers to the reported assets minus the reported liabilities of a company. The equity is what the common shareholders own when they invest in a company. We discussed this concept in owner’s earnings.
How do you calculate Book Value per Share?
It is a pretty easy formula to calculate and find the information. So without any further ado here we go:
Book Value Per Share (BVPS) = ( Total Equity – Preferred Stock) /
Let’s break each variable a little bit to give us a better idea of what they are so we understand how they fit into our formula.
- Total Equity: Total equity refers to the total net assets owned by the shareholders. To find this, we take the Total Assets, and Total Liabilities from the balance sheet and simply subtract them to get our total equity owned by us, the shareholders.
- Preferred Stock: This is a little more detailed, and we can discuss this further in another post in the future. But according to gurufocus.com
- “Preferred Stock is a special equity security that has properties of both equity and debt. It is considered a hybrid instrument. Preferred stock is senior to common stock, but is subordinate to bonds regarding claim or rights to their share of the assets of the company.
- Preferred stock has priority over common stock in the payment of dividends, and any payments received when a company liquidates.”
- Shares Outstanding: Shares outstanding are shares that are authorized, issued and purchased by investors and are held by those shareholders. They have voting rights and ownership in the corporation by the shareholder that holds the securities. Shares outstanding can be either fully diluted or basic. The fully diluted shares include securities such as warrants, options, or convertibles.
- Shares outstanding as we will use them are for shares at the end of the period. These are usually used to calculate balance sheet related ratios such as BVPS.
- While the shares outstanding diluted or basic are weighted shares over a period such as a quarter or a year. They are usually used to calculate income statement or cash flow statement related items such as Earnings Per Share.
Calculating Book Value Per Share
To see how easy this is let’s take a look at several banks and