 and welcome to the session. This is Professor Farhad. In this session, we would look at the book value per share, a topic that's covered in an introductory accounting course, intermediate accounting, and the CPA exam. As always, I would like to remind you to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1700 plus accounting, auditing, finance, and tax lectures. This is a list of all the courses that I cover. If you like my lectures, please like them, share them, subscribe, put them in playlists. If they benefit you, it means they might benefit other people. Share the wealth, especially during the coronavirus outbreak. Also connect with me on Instagram or on my website. You will find additional resources if you'd like to supplement your accounting education and successfully pass the CPA exam. So today's topic is the book value per common share. The book value reflect the value per share if a company is liquidated at the balance sheet amount. What does that mean? It means if the company liquidates today, if they sell everything today, based on their balance sheet amount. So this is an important concept that students overlook. What does it mean on the balance sheet amount? It means based on accounting figures, not not fair value. What does that mean? Let's assume you have a building on the balance sheet that building might be worth a million dollars. The fair value of that building might be worth five million. We're not using fair value. We are using the balance sheet amount. Everything is accounting figures. And remember, accounting figures don't reflect market value. Oftentimes, they reflect historical cost. So what good is that? What good is that ratio for? So first we need to compute how it's computed. Then we would look at its value. So to compute the book value per one share, we'll take the stockholders' equity, which is the stockholders' equity section, that's applicable to common shareholders. What do we mean applicable to common shareholders? It means only the stockholders' equity that belongs to the common shareholders. So if it doesn't belong to the common shareholders, who else sits in the equity section? The preferred shareholders. What we have to do, we have to take out the preferred shareholders when we make this computation. That's why the numerator says stockholders' equity applicable. So notice the word applicable. Very important to common shareholders. Now, if you don't have preferred shareholders, if you don't have this, if you don't have preferred shareholders, then simply put stockholders' equity. The ratio becomes stockholders' equity divided by number of shares of common stock outstanding. But we assume if we have preferred shareholders, we have to take them into account. And we'll see how in a moment. So what do we use the book value for? It's a starting point in many stock valuation. So what happens oftentimes when we are valuing a company to see how much a company is worth? The first thing we look at is what is the book value of that company? Then based on the book value, we can say, well, in this industry, we should value the stock at 10 times the book value. So if the book value is $5 per share, we multiply this $5 per share by 10, we would say that the stock price should be around $50. Because in this industry, the value of this company should be five times its book value. So this is one way to value a stock, or when there's a merger negotiation, price setting for public utilities, and loan contracts. So what they do is they look at the book value as a starting point in that negotiation process. The limitation of the book value is obviously obvious. You are using recorded value. You are using recorded value. And I talked about recording value is accounting values, accounting numbers. Remember, accounting always reflect the past. Not we are not using market value. We are not using market value. Investors often adjust their analysis for the estimate and the difference. So what we do is we say, okay, here's the book value. Let's make a few adjustments to see how much is the company's worth if we convert everything for fair market value. Let's take a look at an example to see how mechanically we compute the book value per share. Then we would look at some actual real companies to compute their book value and see what does that tell us in the real world. Okay, we have the stockholders equity. We have preferred stock $100 per value, 7% cumulative. They have 2,000 shares authorized, of which 1,000 issued an outstanding. That's what we have. And the dollar amount for these is 100,000. That's the preferred. Then we have common stock. We have par value $25, 12,000 shares authorized, of which 10,000 are issued an outstanding. The value is 250. We have paid in capital of 15,000. We have retained earning of 82. We have total stockholders equity of 447. Now, simply put, all the stockholders equity belongs to those 10,000 shares. Except in this circumstances, we have a group of shareholders that sits there and they account for 100 of stockholders equity. That group is a preferred shareholders. So when we compute the book value per share, we have to back them out. And here we are assuming there is no call price for the preferred stock and there is no dividend and error. Simply put, this when we pay off the preferred shareholders, we only have to pay $100 and we don't owe them any dividend. So to compute the book value per share, we'll take 447, which is total stockholders equity. We back out the preferred shared, which is 100,000. What's left is 347,000. Now what we do, we say total stockholders equity applicable to common shareholders, 347,000. This is the numerator and the denominator. We divide this by 10,000 shares. Now, if we do this computation, we find out the book value per share. Simply put, this is a starting point in valuing the company, which is $34.70. Now, let's assume in this industry, the market value of the stock should be 10 times the book value then we'll take. So the price of the stock should be $347 if that's the multiple. Now, how do we determine the multiple? Each industry had a different multiple, just like the PE ratio. If your industry is going to grow and there's a lot of potential for you to earn more profit, your multiple will be not 10, it will be 15. But if your company already old and there's no room for growth, maybe your multiple is only five. So the multiple depending on many factors. Now, let's assume we have a call price for the stock. So the equity applicable to preferred shareholder equal to the preferred share call price or the power value if it's not callable plus any cumulative dividends. If there's any cumulative dividend and a year or any call price, we have to take them out. So the remaining equity is the portion applicable to common shareholders. So let's assume for our example, the callable for the preferred is 108. Simply put, to buy back those 1000 shares, to buy them back to satisfy the preferred shareholders, we have to pay 108. Simply put, now the preferred section, we have to pay the preferred shareholders $108. And let's assume we have two years of cumulative dividend in a year. What does that mean? In addition to paying them a call price, a premium call price, we owe the preferred shareholders two years of dividend. What does that mean? Well, it's a $100 power value 7%. So simply put, if we take $100 times 7%, we have to pay $7 per share. We have 1000 shares outstanding, 1000 shares outstanding. We have to pay $7,000. We are behind two years, we owe them $14,000. Now, what's going to happen is this, our starting point is $447,000. We have to subtract from this number, we have to subtract from this number, $108,000, which is the amount that we have to pay to the preferred shareholder in case we liquidate. Then we have to subtract from this amount the preferred dividend that we owe them. So we'll take $447,000. Let's do the computation deduct from $447,000, $108,000, $447,000, minus $108,000, minus $14,000 for the dividend. What's left is $325,000. This is the amount that's applicable to common shareholders. This is the numerator. We divide the numerator by the denominator of 10,000 shares, 10,000 shares, and we're going to get $32.50 for the price, the book value per share for this company. So notice, as we give away, as we, not as we give away, as the preferred shareholder, as the preferred shareholders are involved in this process, in other words, they take away from the common shareholders. Remember, in the previous example, the book value was $34.70. Now the book value is $32.50. And the reason why it went down, the reason why it went down is because we had to give the preferred shareholder a certain amount of money. Okay, let's take a look at the computation. Hopefully, hopefully you see this. So what's going to happen, we had to deduct from the $447,000, not only $100,000, as in the prior example, we had to deduct $108,000 because the cold price $108,000, and we had to pay them two years of dividend. So our book value went, went down. Now let's take a look at three examples, just kind of so you see how the book value is used. For example, here we are looking at Apple. Apple book value as of today is April 21st. So this is April 21st, 2020. The stock price of Apple is around, I don't know when I did this, around $270. I don't know exactly what it closed that, but I can look it up, give me one second, please, because just make it, because this will change a little from the time I took the price. Let me see how much Apple it closed at, basically. So give me one moment, please. I'm looking at my phone. Apple closed at, let's see. Sorry about that. Just my phone is not $268.37, $268.37. This is the price of Apple. Now what's going to happen is the book value of Apple is $20.42. So what I'm going to do, I'm going to take $268.37. I'm going to take $268.37, the closing price divided by $20.42, and Apple is trading at almost $13.14 its book value. So Apple, we take the book value and multiply it by 13 times. That's the price of Apple. Is this overpriced, underpriced? The market will determine if this multiple 13 time is big or small. We can do the same thing for Microsoft. It's $168. This is the price when I checked it. And the book value is $14. So if we take $168 divided by $14.47, the book value per share, Microsoft is trading at 11.61 times its book value. We say that Apple is more expensive, because Apple is trading at 13 times its book value. And here we have Walmart. Again, those are not the final prices. This is when I was preparing the slides. If we take $129.55 and we divide it by the book value per share, which is $26 and let's see $129.55 divided by $26.36. Oh, wow. Let me do it one more time. $129.55. $129.55 divided by $26.36. The book value, the multiple is $4.91. Let's make it $5. Just surround it. So the multiple of Walmart is $5. So from a value perspective, Walmart is way cheaper in terms of book value from Apple and Microsoft. So simply put, we're taking Walmart book value times $5. And this makes sense, because if you're a technology company, you have more room to grow. Therefore, your multiple should be higher than a company like Walmart, that business is relative to Microsoft and Apple is boring. It's a good business, but it's boring. There is no new innovation versus Apple and Microsoft. They could come up with a new innovation anytime during the year. So this is basically the book value per share. If you like this recording, please like it, share it, subscribe, visit my website for additional resources, especially if you are looking to study for your CPA exam, to pass the exam, put it behind you, succeed in your career. Study hard, stay safe, especially during those coronavirus days. Good luck.