Book V Market Understanding Financial Concepts in Essay

Book v Market

Understanding Financial Concepts in the Real World: Book Value v. Market Value in MAKO Surgical Corp

Few economic events in recent memory have thrown the basic concept of book value vs. market value into sharper relief than the dramatic and ongoing changes in home prices across the country. Many homeowners found themselves “underwater” or “upside-down” on their mortgages, meaning that they owed more money for their homes than they were actually worth — it was often more advantageous for these individuals to simply walk away from their homes and default on their loans. Yet how is it possible, one might wonder, for a home to be worth less than what was paid for it assuming it was still in the same basic condition? This is precisely where an understanding of the difference between book and market value becomes necessary, and where the frustrations of many homeowners truly intensifies.

Ultimately, any commodity — whether it is a loaf of bread or a piece of real estate — is only worth what some is willing to pay for it. Very simply put, this price is he market value of the commodity or asset; it is the price that a seller can expect to receive and a buyer can expect to pay for a given commodity. As the housing market has shown, market value can change daily and create a great deal of uncertainty. This is in sharp contrast to the book value of a commodity, which is the actual price paid for an actual item (or house) rather than the hypothetical value of the same item. This value is essentially fixed; as long as the commodity exists, its book value is its last sale price. Things are more complicated with something like a house, but the concept remains the same.

With something as large and complex as a house, there are bound to be other factors that effect the book value over time — the purchase of a new water heater increases the book value, while the window that is now a tarp because of some kid’s baseball decreases it. Note that these are not market forces affecting value, but rather direct and concretely quantifiable changes to the value of the structure as a whole. The same sort of complexities and addendums apply to a discussion of the book vs. market value for a given company or its stock — the market value is what someone in the market is willing to pay for a piece of the company, while the book value is the actual cost of that piece (Ross et al. 2006). Put most simply, the book value of a company is the total of its assets less its total liabilities; this number divided by the umber of shares in the company is the book value of each individual share. This number is far more stable than the market value, though it says nothing about investor confidence in the company’s future, which includes a valuation of intangible assets (Sweeney et al. 1997).

MAKO Surgical

MAKO Surgical Corp. (NASDAQ: MAKO) is a relatively new company that makes one thing, and makes it well: robotic surgery tools. The company only recently released its second line of machinery, designed to perform certain hip surgeries; the company was founded in 2004 with its design for a similar instrument that operates on knees (MAKO 2011; Yahoo Finance 2011; Hoovers 2011). Though all of this company’s assets and liabilities are still quite new, and examination of this company provides a useful comparison of book vs. market value.

To begin with, the simple mathematics of the differences between book and market value as described above can be calculated from the company’s most recent available data. Though there are actually many more complexities to a calculation of accurate book value other than simplt a subtraction of liabilities from assets, this provides a useful starting point for an understanding of book value and how it relates and compares to market value. The most current annual report for MAKO Surgical Corp. is their 2009 report, published in 2010 and including all relevant cash flow and asset/liability data through December 31st, 2009; this is the data that will be used to calculate the book value of the company. An examination of current stock prices as well as first quarter 2010 stock prices (reflecting the period for which the 2009 data is most relevant) will provide the market values for the company, illustrating the manner in which they change as well as allowing for comparisons with the book value.

At the end of 2009, MAKO reported total assets in the amount of just under $100 million (99.103 million, to be exact), with total liabilities of just over eight million (8.309 million). This gives the company a book value of 99.103-8.309, or 90.794 million (MAKO 2011). Divided by the number of outstanding shares in the company (33,036,378 in 2009) yields a per-share book value of $2.75 — in other words, for every $2.75 of net assets the company has (i.e. assets minus liabilities), there is one share of outstanding stock (MAKO 2011) . Remember, though, that this is the book value of the stock and not the market value, and though a stock can trade at its book value this is rarely the case in reality.

Market value is much more a measure of what individuals believe something will be worth, rather than just a measure of what they believe it is worth (Sweeney et al. 1997). Though MAKO’s most recent comprehensive financial statements indicate that there is only about three dollars’ worth of real assets for every share of stock in the company, the most recent trading price for the stock was $17.49, almost seven times its book value in a the end of 2009 (Yahoo Finance 2011). A more fair comparison would be an examination of the trading price — i.e. market value — for the stock in the first quarter of 2010, when the information contained in the 2009 Annual Report still represented a current and accurate assessment of the company’s financial standing. During this period, the stock was trading at around $13, still showing that there was a great deal of confidence in the company’s future and thus that the stock price should reflect potential future earnings and values, and not just the current book value.

Examples and Complexities

In reality, there are numerous factors other than simple asset and liability changes that affect the book value of a company, and other forces that have much different effects on the market value of a company (Ross et al. 2006). While the paying off of debt equals a direct reduction of liability, the increase in book value is not so direct — issues such as the interest rate being charge on any outstanding debt, which could be tax deductible in the current year, must be calculated in order to determine the actual change in book value that occurs Ross et al. 2006). The result would still be a reduction in liability and an increase in book value, but perhaps not as large as might be thought.

This same transaction could potentially have a very different effect on the market value of the company. Investors could see the paying down of liability — something MAKO engaged in heavily during 2009, given that its 2008 liabilities were $20.million, or more than double the 2009 total — as a poor move given the cheap costs of borrowing and the opportunity cost of paying down debt (MAKO 2011). This could lead to a drop in the market value if investors thought the long-term interests of the company were not served by the decision. Another transaction, such as the sale of a major asset — say the company consolidates its manufacturing center…

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