 Hello, and welcome to the session in which we would look at the book value per share. What is the book value per share? What's the big idea? Well, basically it's finding the price of the company based on the book value. The book value means the accounting value rather than the fair value. Each company, if it's publicly traded like Google, PepsiCo, Walmart, so on and so forth, they have a fair value price. It means a price that people buy and sell on the market. Well, guess what? There is another accounting price, and that accounting price is called the book value per share. Simply put, it's signing a stock price, but that stock price is based on the balance sheet. Now, there are a lot of issues with that, and we'll see why in a moment. But remember, the balance sheet figures are historical data, like, for example, property, plant, and equipment, land. Nevertheless, it might give us some idea about the prospect of the company by finding that book value. Now, how to compute this stock price? That's the book value. It's pretty straightforward. Basically, we're going to take the equity section that belongs to the common stockholder, so the equity section minus any preferred stock claims. Now, the computational becomes a little bit involved when we have preferred stock claims, and this is what we will work in this session to work examples, divide by the ending number of shares. Or you might see it in your textbook as common shareholder equity, which is common means no preferred, but when you say common, it means take out the preferred divided by the ending number of shares. The formula is pretty straightforward, pretty easy to compute unless you have some preferred stock claims. What could be those preferred stock claims? Well, they could be you could have cumulative preferred. We talked about this where you have to take into account every year, the dividend regardless whether they declare it or not, just like computing earnings per share, you could have dividend and arrears. Dividend and arrears, when the company has a cumulative preferred and they are behind, behind it means they missed one or two years. Now what you have to do, you have to take those dividend and arrears into account in your computation. Sometimes there's a call premium. What is a call premium? Call premium is when the company have the right, they have the right to call the preferred stock and usually they pay a premium, a price above that. Well, if that's the case, you have to take that call premium into account. And the preferred stock could be fully participating or not fully participating. We'll work examples that's fully participating to illustrate the point. But once you grasp the basic idea about that you have to take out the preferred stock claims when computing the book value per share because the book value per share is the value to the common stockholders. This is what we're computing. Now in this example, as I'm going through the numbers, I will compute the book value for the preferred stock as well to give you an idea. You'll be able to kind of see the full picture. What is the general rule from a business perspective about this? The general rule is this, the fair value of the stock should be higher than the book value. In other words, when you look at the company stock, the stock price that's traded on the market should be higher. Otherwise, if that's the case, the company is undervalued. What does that mean? It means if you sell the company, you'll get, if you sell, if you liquidate the company because the book value is based on the book value is based on the book value, based on the accounting figures, based on the balance sheet figures. So in other words, if the book value is higher, liquidate the company and the shareholders are better off. So generally speaking, fair value should be higher. Or if the fair value is not higher, the company is extremely risky. It means for some reason, no one likes this company. That's why the fair value, no one is buying their stock. And I will show you an example in the real world about both, where the company had low book value and high book value. So otherwise you are better off liquidating the company. And the best way is to show you a few companies, a few samples, a few real time book value and discuss them just to get to look at the big picture. Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true false questions, as well as exercises. Go ahead, start your free trial today, no obligation, no credit card required. The first company I'm going to look at is Apple, which is trading right now the fair value of the stock price based on the closing 176.28. Again, when you're looking at this, it might have a different number. No, Finance Yahoo will give you the book value per, for any company you are looking for. So the book value per share is $3.84. What does that mean? It means if you look at the balance sheet of Apple, their cash, whatever assets they have, intangible assets, goodwill, minus their liability, you come with their equity and you take their equity and you divide it to the common shareholders. The company is worth a little bit less than $4. The company is worth actually 176. So if we take 176.28 divided by $3.84, it means Apple is trading approximately 46 times its book value. What does that mean? It means Apple value, not from its asset. Apple value is from its earnings, because it earns a lot of profit and that's why. So the balance sheet is really meaningless when you look at Apple. What matters is what people are paying, what investors are paying is for their potential profit. Now I'm going to compare and contrast Apple. Again, they're not comparable, but I'm trying to give you a different book value to get to the point. A company like Bank of America. Bank of America stock price is $44. If we look at their book value, their book value is $30.22. So if we take $44.42 divided by $30 and some odd change, Bank of America is only trading at one little bit less than one and a half times its book value. So it's traded at one and a half time. At some point, Bank of America book value at some point was higher than the fair value. This was an exception because of the financial crisis. They had a lot of those collateralized mortgage debt, which there were bad assets. So it was reversed, which is unusual. So the point is a company like Bank of America, it's totally different than Apple. Why? Because if you look with their assets today, you can get $30, but the stock price is traded at $44. Now frankly, if we look with their assets, they will not even get $30 because they still have those bad investments and bonds, but that's a different story. I'm going to look at one more company like Normal. It's not like Bank of America. It's not Apple. Something in between and that's Darden. That's Darden Company, which is the rest. It's Darden. Let me just put it up. Darden Restaurants, it owns a few other companies. If you don't know what this company is, let me take a look at their profile. It's good to see. Good job, Adam. You would see what they do just so it gives you an idea. They own the Olive Garden. They own Longhorn Steakhouse. So it's good to know what the company is in the business. So they own many restaurant chain. So let's take a look at Durbuk Value. They're trading at $146.11. And if we look at Durbuk Value, let me scroll down. Durbuk Value is almost $20. So if we're looking at $146 divided by 20, a rough estimate, dirt trading at $7.3. Again, the reason I said this is a rough estimate because the price could change tomorrow and this could change. So they're trading at $7.5 Durbuk Value. That could be normal. That could be the normal thing for restaurants. So for a restaurant, when you value a restaurant, you look at Durbuk Value, you multiply it by $7.3. Now, then you can go ahead and make decisions, look at competitors to Darden Restaurant, and see if that relationship stands, seven and a half times Durbuk Value. So this is how Durbuk Value is used in the real world. So from a financial perspective, from an analyst perspective, of course, the Durbuk Value is looked at when evaluating a company. Let's go back here and start to look at actual computation. We're going to be using this Aram company and they have capital stock, they have common stock, preferred stock, they have retained earnings. We're going to try to compute Durbuk Value under several scenarios, starting with a simple scenario to illustrate the point. Then we'll make the example a little bit more challenging. So let's start to compute Durbuk Value per share for this sample company. First, you have to understand how to read the statements of stockholders' equity. So this is only a partial balance sheet. This is only the stockholders' equity. So for this company, we have preferred stock, we have common stock. The preferred stock is $50 per share. It's 8% for this example here, non cumulative, non participating, keeping it simple. They have 5,000 authorized of which 3,000 issued an outstanding. Well, if it's 3,000 issued an outstanding, we're going to be paying the dividend to only those 3,000 shares. And notice if we take the par value times the 3,000 will give us 150. Common stock, we have a common stock with a par value of $10, 50,000 shares authorized of which 40,000 outstanding. So if we take $4 times 40,000 will give us 400,000. So this is 550 is total capital stock and we have additional paid in capital for the preferred 40 for the common 100, 140. So this is total paid in capital. We have retained earnings of 150 and stockholders' equity of 840,000. So what we're going to do is this. Remember, we have stockholders' equity of 840,000. This stockholders' equity, because we have preferred stock, we have to back out the preferred stock, whatever belong to the preferred stock and what's left belongs to the common. Whatever's left belongs to the common, we're going to take it and divide it by 40,000 shares to come up with the book value. So let's do this. Let me just show you the number so it's easy to look at it. And here we're going to assume it again. We said it's non cumulative. We'll talk about this in a moment. So what belongs of the 840,000? This belongs to the preferred 150 and this belongs to the preferred. So what belongs to the preferred is 190 and the remainder belongs to the common. What belongs to the common is 650,000. We're going to take 650,000 divided by 40,000 shares to book value per share for the common is $16.25. If we take 190,000, what belongs to the preferred divided by the number of shares for the preferred. And this is really in the real world. You don't use this a lot. I'm just giving you the example to kind of tell you that you could also compute the book value for the preferred. But the problem with the preferred in the real world, you have many types of, many different types of preferred. That's why you can't do that unless the company has only one type of preferred. So the book value of the preferred $63.33. I'm going to be using the same sets of data in working different scenarios. So bear in mind the total equity should be 840,000. Always check yourself that this is equal 840 and how you split it between preferred and common. Let's change the example a little bit, just a minor change. In this minor change, we're going to make the preferred cumulative. When the preferred is cumulative, you have to take into account the dividend, whether it's declared or not. Because once it's cumulative, it's you are responsible for it. So it's a good idea now to practice how to compute the dividend for the preferred. How do we compute the dividend for the preferred? We'll take the par value times the rate. So each preferred share gets $4 per share in dividend. We have $4. We have 3000 shares authorized and shares issued and outstanding. So the shareholders are going, the preferred shareholders will get 12,000. So where does the dividend comes out? The dividend comes out of retained earnings. So here's what's going to happen now. Just like the prior example, we have the preferred stock paid in capital. Now under the preferred column, we're going to give them an additional $12,000. This additional $12,000, it's going to come out of retained earnings. So notice retained earnings for the common went down. Now the common equity is 638,000. The preferred, what belongs to the preferred is 202 remember to always add them up. They'll add up to 800 and should add up to 840. Now the common book value of the common stock is $15.95 lower than the previous one. The previous computation, the book value for the preferred 6733 actually higher than the previous one. Now let's change the scenario a little bit and assume that the preferred stock is cumulative and it's two years in a year. It means they owe the shareholders two years. What does that mean? Every year remember we have to pay the shareholders 12,000 because it's a cumulative. If we don't pay it, we owe it to them. Now if we are two years behind, we owe them 24,000 and this year we owe them 12. So we owe them 36. Now when we do the computation, we're going to give the preferred column 36,000. So we're going to reduce retained earnings from 150 to 114, and it goes to the preferred. Now if we add up what belongs to the common 614,000, the book value is $15.35, what belongs to the preferred 226 divided by 3000 shares, the book value is $75.33. Now let's change the scenario a little bit and assume the company is paying 50,000 in dividend. However, we're going to assume the preferred dividend is fully participating. Now in a prior session, I explained what fully participating is. In this session, I'm going to go ahead and illustrate the concept of fully participating. Well, let's start. Well, we have to pay, again, first the preferred dividend. The preferred dividend $50 per value times 8% equal to $4 per share, $4 times 3000 shares of preferred stock, we're going to have to pay them $12,000. So I'm going to keep it simple. I'm not going to have any dividend in a year. So the first we're going to give $12,000 to the preferred shareholders. The common shareholders, they're going to get also 8% the same rate, which is $10 power value times 8% equal to 80 cent times 40,000 shares issued and outstanding. And that's going to give them $32,000, which in total we gave in total so far $44,000. Now remember, we are paying $50,000 and the preferred are fully participating. Now what do we have to do? We have to find out what's left. Well, obviously what's left is $6,000 that we have to distribute to the common and to the preferred because the preferred, they are going to participate. Now we have to find the rate. What participating rate we have to compute? Well, we're going to take what's left $6,000 and divide the $6,000 by $550,000, which is the total of the preferred stock and the common stock, which is $150,000 plus $400,000. And that's going to give us a rate of 1.09090909 rounding, just 1.0909. The reason I say this because in your calculator you might see slightly different numbers because of the rounding. So what's going to happen is this. Now we have the participating rate. We're going to take $400,000 multiplied by that rate and the common shareholders they're going to get of the $6,000, $4,363.60. And obviously what's left goes to the preferred, but if we take $150,000 times 1.090909 rounding, they will get $1,636.40. Again, this is rounding. I rounded it and this is how I distributed the remaining $6,000. Now we are ready to see what's the total for the preferred, what's the total for the common, and the total is $50,000 distributed. Now we are ready to compute the book value per share. Now notice under the preferred we have the $150,000. We have the paid and capital preferred, which is these are from the balance sheet number. Plus we have to give the preferred $13,636, which is going to come out of our retained earnings. For the common, they're going to get the $500,000, the $400,000, and the $100,000, which is $500,000. And what's left of the retained earnings was $150 minus the preferred, minus what we paid for the preferred, what's left is $136,364. Now we add the preferred, we add the total, then we'll take the total preferred divided by the outstanding shares. The book value for the preferred is $67.87. Same thing for the common, we'll take the total common equity divided by 40,000 shares outstanding, which is right here, the outstanding shares $40,000 and $3,000 will give us $15.90 per share for the common stock. What should you do now? Go to Farhad Lectures and work MCQs through false additional exercises that's going to help you understand this important concept. Good luck, study hard, and stay motivated.