Lesson 8 of 8 · All lessons in this module
- Equity versus debt, why companies issue shares, and equity in global markets
- Common shares: voting rights, share classes, callable and putable shares
- Preference shares: cumulative, participating and convertibleVideo lesson
- Integrated cases: share classes, control and the liquidation ladder
- Private versus public equity: venture capital, buyouts and PIPEs
- Investing in foreign equity: direct, depository receipts, GRS and BLDRs
- Risk and return of different equity securities
- Book value, market value, ROE and the cost of equityVideo lesson
Lesson 8 of 8 · 15 min
Book value, market value, ROE and the cost of equity
Book value records what management has built; market value prices what investors expect it to build. ROE judges how well book equity is used, and the cost of equity is the return investors demand for supplying it.
In short
- Book value of equity = total assets − total liabilities; it grows when the company retains net income. Management affects it directly, market value only indirectly.
- Market value (market cap = price × shares) reflects investors' expectations of the amount, timing and uncertainty of future cash flows; it rarely equals book value.
- ROE = net income available to common shareholders ÷ average (or beginning) book equity. Use one version consistently.
- A rising ROE is not always good: it can come from net income falling slower than equity, or from debt-financed buybacks that add leverage.
- Price-to-book = market price per share ÷ book value per share; higher means investors see more future growth opportunities. Compare within an industry.
- The cost of equity is the minimum expected return a company must offer to sell and support its shares; it is hard to estimate and is used as a proxy for investors' minimum required return.
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