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 financial institution’s balance sheets to learn how to calculate this formula.
First let’s take a look at Wells Fargo (WFC).
Okay, so let’s pull some numbers from the balance sheet to start plugging into the formula. All numbers stated will be in millions unless otherwise dictated.
First, we will need the Total Equity which is $199,581. Next, we will need the preferred stock which is $24,551.
Next set of data we will need is to find the shares outstanding. You will notice that I highlighted two sets of numbers for us to take a look at. To find the shares outstanding, we are going first to need to reduce the share count by the treasury stock from the share count.
Why do we do this? Because the treasury stock is not part of the shareholder’s equity and thus we need to reduce the share counts to account for this.
Notice on the balance sheet that they have reduced that value from the total shareholder’s equity.
The share count that we are using is 5481, and the share count for the treasury stock is 465.
Now, plugging all the numbers into the formula, we are going to get our result.
BVPS = ( Total Equity – Preferred Stock / Shares Outstanding
BVPS = ( 199,581 – 24551 ) / ( 5481 – 465 )
BVPS = 175,030 / 5016
BVPS = $34.89
Pretty darn easy, huh?
Next up let’s take a look at Goldman Sachs (GS)
Taking the numbers from the balance sheet.
Total shareholders equity: 86,893
Preferred stock: 11,203
Shares Outstanding: 873
Treasury Shares Outstanding: 480
Let’s plug the numbers into our formula and see what the results will be.
BVPS = ( 86893 – 11203 ) / ( 873 – 480 )
BVPS = 75690 / 393
BVPS = $192.76
Next, let’s take a look at another financial institution that you may not have heard much about, although they are one of the larger insurance banks in the country.
Cincinnati Financial (CINF)
CINF offers property and casualty insurance, and it has over 1% of the domestic property and casualty premiums in the US, which ranks it as the 20th largest insurance company in the US by market share.
A little more tidbits about the company, they are one of the rarified companies that are considered a dividend king, which means they have raised their dividends for 56 consecutive years.
There are only 18 companies that can qualify for this status, so they are special indeed. And chances are you have never heard of them, and they are certainly not in a sexy business. If you would like to learn more about this company, follow this link
Getting back to calculating our book value per share, let’s dive deeper into Cincinnati Financial’s balance sheet.
Total shareholders equity: 7060
Preferred Stock: 0
Shares outstanding: 198
Treasury shares outstanding: 34
Plugging in our numbers, we get this result.
BVPS = ( 7060 – 0 ) / ( 198 – 34 )
BVPS = 7060 / 164
BVPS = $42.94
Next up, we will try a smaller bank, SunTrust Bank (STI) which is a regional bank centered around the southeastern US. I am familiar with the bank from my time in Nashville.
They are a member of the S&P 500 and they have a market cap of $26.98 billion, so it is considered a medium size bank.
Gathering the numbers for our formula.
- Shareholders equity: 23,618
- Preferred Stock: 1225
- Shares outstanding: 491
Plugging all those numbers into our formula.
BVPS = ( 23618 – 1225 ) / 491
BVPS = 22393 / 491
BVPS = $45.60
For the final look at book value per share, let’s take a look at Met Life, an insurance company.
Picking out the numbers from the balance sheet.
- Shareholder’s equity: $67,309
- Preferred stock: 0
- Shares outstanding: 1164
- Treasury stock outstanding: 68
Plugging all the numbers into our formula, we get:
BVPS = ( 67309 – 0 ) / ( 1164 – 68 )
BVPS = 67309 / 1096
BVPS = $61.41
That wraps up our look at the balance sheets of many different financial institutions and banks.
As you have seen calculating the book value per share of banks is pretty easy, and you can use this same formula to find the book value of any company you wish.
Calculating book value per share is fairly easy, but you are probably wondering why do we do this exercise?
It is another brick in the wall to help us value a bank or financial institution. Along with return on equity, return on assets, efficiency ratio, among others this formula can help us find the real value of a bank.
Warren Buffett has said several times that we should value a bank exactly like we would value any other company.
These tools that we have looked at are just one more step along that path.
As for the book value per share, the value it brings to our process is that it helps us find a truer picture of the bank’s assets.
Unfortunately, calculating BVPS does not always reflect the true value of let’s say Apple.
Why is this?
Because the assets carried on the balance sheet at the original price minus depreciation, this could lead underestimating the true economic value of the assets of the company.
Also, it may overestimate the economic value of the same assets at the current market value, even though those assets may be obsolete.
For banks and financial institutions, their assets may be reported at market value. Book values of financial companies are a more accurate predictor of the economic value of the company.
Another benefit of calculating this formula is that it helps calculate another ratio which is the price to book value, or the P/B.
Price to book is a favorite of value investors as it gives a good indication of the relation of the book value of the company about its price.
A great way to find undervalued companies is to look at the price to book ratio, anything under a one is considered undervalued in correlation to its equity.
These are the companies that we want to dig into more, to see if there is something there worth valuing. Price to book is a subject that we can delve into further sometime in the future.
As always remember that finding a great book value per share is not the end all, be all for locating a great company to invest in. These formulas that we have been discovering are just building blocks in our search for intrinsic value and a margin of safety.
Thank you for taking the time to read this post, I hope you found some value in it.