TheStreet

Anyone committed to making money in the stock market should know the meaning of the term "book value per share."

Smart market mavens are always hunting down the next Amazon (AMZN - Get Report) or Apple (AAPL - Get Report) before they emerge on the stock market radar and attract too much attention from investors. Those stock, when in their infancy, gave savvy investors exactly what they look for a stock with potential - largely undervalued stocks.

One proven way to identify stocks that are grossly undervalued is through determining their book value per share.

Book value a key determinant in a healthy, yet under-rated stock. Publicly-traded companies always include key financial factors like earnings, debt and assets in their public reporting statements. For better transparency, companies break these factors down more thoroughly so interested investors can better evaluate the company stock.

Book value per share is one way for investors to do that - especially value-minded investors who are looking for a good stock at a discount.

Let's kick some tires on book value per share, see how it works, and examine what value it brings to the table for investors.

What Is Book Value Per Share?

Simply stated, book value per share defines the accounting value (i.e., book value) of a share of publicly traded stocks.

Also defined as a firm's next asset value, book value per share is essentially the total assets of a company, but not counting a firm's assets and liabilities.

When book value per share is high compared to a company's share price, the company's stock is deemed as undervalued.

Put another way, book value per share rates the total shareholder's equity of a stock in relation to the amount of shares outstanding. Analysts who do this on a regular basis are looking to see if the market value per share is beneath the book value per share.

If that's the case, a company's stock may well be undervalued.

Investors looking to apply book value per share to a stock should look at a firm's balance sheet, which will include the necessary ingredients to ascertain book value, such as total asset value and the cost of acquiring an asset. On the balance sheet, you'll also find the accumulated depreciation of corporate assets, which aids in getting the most accurate outcome when it comes to book value per share.

Calculating book value per share isn't necessarily complicated.

Basically, you're subtracting a company's preferred stock from shareholder equity, and divide that sum by the average amount of stock shares outstanding.

Here is the formula for book value per share, from the folks at YCharts.com:

Book Value per Share = (Shareholders' Equity - Preferred Equity) / Total Outstanding Common Shares

For a more real-world example of book value per share in action, let's turn to AccountingTools.com, which offers this scenario:

XYZ stock has $15 million of stockholders' equity, $3 million of preferred stock, and an average of 2 million shares outstanding during the measurement period.

The calculation of its book value per share is:

$15 million Stockholders' equity - $3 million Preferred stock ÷ 2 million Average shares outstanding

= $6 Book value per share

Three Things to Know About Book Value Per Share

While it's critical to understand the definition and calculation of book value per share, it's also important to know why the stock assessment model is used and what it means to you as an investor.

Here's a closer look:

An essential tool for value investors. Book value per share is most widely used by so-called value investors, whose champion is Warren Buffet. These investors are always looking for a discount, and book value per share gives them a useful tool to buy a stock at real value.

For instance, when a stock trades below its book value, that's a green light for value investors, who view that scenario as a chance to purchase shares at a price that is actually lower than the stock's value.

Book value isn't the same as market value. While book value per share is a good way to evaluate a stock, it's more of an accounting-based tool and doesn't necessarily reflect the true market value of a publicly traded company - companies have varying accounting models to figure out book value, and all models aren't the same, and are dependent on C-level management's discretion.

What book value and market value can do is let an investor know whether the bulls or bears are running on Wall Street. Basically, if a company's market value is significantly stronger than its book value, it's a bull market scenario. If the opposite holds true, and book value and market value are more tightly bundled together, then the market is more likely in a bear market scenario.

Book value per share is a fairly conservative way to measure a stock's value. The book value of a company, stripped to basics, is the value of the company the stockholders will own if the firm's assets are sold and all of the firm's debts are paid up.

That definition represents a cautious, even conservative measure of a stock's potential value.

That's especially the case when compared to other stock valuation models, such as an earnings-based calculation where future company growth and earnings projections need to be added to the mix. That said, conservative stock valuation models like book value is likely a better gauge of a stock's potential value, as earnings-based models, with all the future growth and earnings projections necessary to get a final verdict, are less stable.

Book value per share is highly useful for investors to get a real-world view of a company's equity value. Any security trading for less than its tangible book value is manna from heaven for value investors, thus underscoring the need and importance of book value per share.

If you're looking to get a better grip on the value of a company, based on its internal financials, book value is a good - but not the only - measuring stick.