Tangible Book Value
The term tangible book value refers to a measure that allows the investor-analyst to understand the value of an organization after removing intangible assets and goodwill. Tangible book value is of particular interest holders of common stock, which may want to know the value of a company in the event of liquidation.
Tangible Book Value = Book Value – (Intangible Assets + Goodwill)
Book Value = Total Equity – Cost of Preferred Stock
- The value for total equity can be found on the company’s balance sheet. It can be determined by adding additional paid in capital plus par value of common stock plus retained earnings.
- The cost of preferred stock is equal to any unpaid preferred dividends plus payback of the purchase price of preferred stock.
- Intangible assets and goodwill are typically those assets purchased at a price that is above market. These assets can be found on the company’s balance sheet.
Return on investment measures allow the investor-analyst to understand the company’s ability to provide investors with an acceptable return on their money. This is usually assessed by examining metrics such as net worth, returns on equity or assets, earnings, economic value added, and dividends. Return on investment metrics provide analysts with a way to determine a fair price to pay for a share of common stock. One of the ways to understand return on investment is by measuring a company’s tangible book value.
An investor-analyst can better understand how much money is left over after all of the company’s liabilities have been deducted from its assets by calculating the company’s tangible book value. As is the case with net worth, liabilities are subtracted from assets. Tangible book value, however, goes one step further and removes goodwill and intangible assets from net worth. By its very definition, goodwill represents the value the company paid in excess of market. For that reason, tangible book value is considered a superior indicator of the money that could be distributed to holders of common stock in the event of liquidation.
The manager of a large mutual fund would like to understand the risk associated with holding shares of Company ABC common stock. He asked his analytical team to review the balance sheet of Company ABC’s most recent annual report as well as the details of the preferred shares it has issued and tell him how much money is available to holders of common stock in the event of liquidation. The team found the following:
- Total equity account balances included retained earnings of $6,500,000, additional paid in capital of $57,350,000, and common stock par value of $3,000,000.
- Liquidating preferred stock would mean purchasing it back at $10,500,000 and paying dividends of $1,050,000.
- The company also had a goodwill balance of $3,500,000.
Using this information the team calculated the tangible book value as:
= ($6,500,000 + $57,350,000 + $3,000,000) – ($10,500,000 + $1,050,000) – $3,500,000= $66,850,000 – $11,550,000 – $3,500,000, or $51,800,000
When examining the assets held in goodwill, the analysts pointed out to the fund manager that Company ABC held what might very well be valuable patents in the event of liquidation. As such the fund manager asked his team to also calculate the company’s book value per share.