How to evaluate if a stock is expensive or cheap: the book value formula

Have you ever wondered if you’re really buying a stock at a good price? The answer isn’t always in what you see on the screen. There is a fundamental tool in investment analysis that many traders ignore or minimize: net book value. This metric is especially valuable for identifying opportunities that the market is not valuing correctly, and it is the central pillar of the strategy known as value investing.

The contrast between what we pay and what it is really worth

When you invest in a stock, you are often paying not only for what the company has now but also for what you expect it to have in the future. This is why the market price rarely matches the actual value reflected in the company’s accounting books.

Let’s consider a practical example: a stock could have a net book value of 15 euros but be trading at 34 euros. Is that differential justified? It depends on your expectations about the company’s future performance and the sector. However, this is precisely where deep knowledge of how to calculate and interpret these metrics comes into play.

What does net book value really mean

Unlike the nominal value of a (share, which is only calculated at the time of issuance and considers only the share capital), net book value reflects the company’s own resources at any point in its operational life. Essentially, it is the sum of share capital plus all accumulated reserves.

This concept is also known as “Book Value” in professional investment literature. Its relevance lies in allowing you to see, with tangible data, the net worth that each share represents within the company’s total structure. Through this objective information, value investors can detect companies whose market price does not reflect their true accounting solidity.

The formula for net book value: breaking down the calculation

The process to obtain net book value is straightforward, although it requires access to the financial statements published by the company. The basic formula is:

Net book value = Assets - Liabilities

When analyzing individual stocks, we divide that result by the total number of shares outstanding:

Net book value per share = (Assets – Liabilities) / Number of shares

Let’s put real numbers: if a company has 3,200 million in assets, owes 620 million, and has 12 million shares outstanding, the calculation would be:

(3,200,000,000 – 620,000,000) / 12,000,000 = 215 euros per share

This is the book value of each share. Now, if that same share is trading at 84 euros in the market, we could be looking at an opportunity, or if it is trading at 600 euros, we would be facing a significant overvaluation.

The P/B ratio: your compass to detect imbalances

Once you understand how the net book value formula works, it’s time to introduce the tool that integrates this metric with the actual price: the Price/Book ratio (P/B).

The calculation is direct: divide the current market price by the net book value per share. A result above 1 indicates that the market is paying more than what the books say the company is worth, while a result below 1 suggests the opposite.

Let’s take two hypothetical companies: ABC has a book value of 26 euros and trades at 84 euros (P/B = 3.23), while XYZ has a book value of 31 euros but trades at only 27 euros (P/B = 0.87). In theory, XYZ presents a more attractive price-to-value ratio from a value investor’s perspective.

In practice, these ratios are reflected on specialized platforms. Acerinox, the Spanish steel company, has historically shown low P/B ratios, suggesting undervaluation relative to its book equity. Conversely, Cellnex, a Spanish telecommunications infrastructure company, typically exhibits higher ratios, indicating a valuation above its book value.

How net book value behaves in theory versus reality

Net book value is one of the pillars of fundamental analysis, clearly differentiating from technical analysis, which is based on historical price patterns. However, it’s crucial to understand its limitations.

The first significant limitation is that it completely ignores intangible assets. This is especially problematic in the tech and biotech sectors, where a software platform may have a relatively low development cost but generate massive revenues. The P/B of these companies is often considerably higher than the average of other sectors, not necessarily because they are overvalued, but because the metric does not capture the true value of their intellectual property.

Additionally, the metric performs poorly with small-cap companies. These firms are often newly created, so their book equity is far from their growth ambitions and future profitability.

There is also the risk of “creative accounting,” a term describing the use of legal but biased techniques to manipulate results: overvaluing assets and undervaluing liabilities. A manipulated balance sheet can lead us to completely false conclusions about the company’s true solidity.

The most emblematic case in the Spanish market was the IPO of Bankia in 2011. At that time, the bank was trading at a 60% discount to its book value, which should have seemed like an extraordinary opportunity from a value investing perspective. However, the entity later suffered a catastrophic performance that ended with its absorption by Caixabank in 2021. This example clearly illustrates that a low P/B ratio does not guarantee a positive future performance at all.

The right place for this metric within your investment analysis

Net book value should be considered as one component of fundamental analysis, never as the sole decision criterion. Within this broader analysis, we should also consider:

• Macroeconomic conditions
• The company’s competitive positioning within its sector
• Management quality and track record
• Real revenue growth prospects
• Debt levels and balance sheet sustainability

Only when all these variables align favorably, and the net book value also suggests undervaluation (P/B below 1), do we have a convergence of signals that can justify a well-founded buying decision.

In conclusion, mastering the calculation and interpretation of the net book value formula is an essential skill for any serious investor, but it must always be combined with a thorough analysis of the company’s overall situation and its real competitive prospects.