Book to Market Ratio What Is It, Formula, Example

If a P/B ratio is less than one, the shares are selling for less than the value of the company’s assets. This means that, in the worst-case scenario of bankruptcy, the company’s assets will be sold off and the investor will still make a profit. The current stock price is readily available from the exchange on which it is traded. The Book to Market ratio compares the book value of equity with the market capitalization, where the book value is the accounting value of shareholders’ equity. It is computed by dividing the current book value of equity by the market value. In contrast, market capitalization is determined based on the price at which the stock is traded.

Book To Market Ratio

Either way, it’s helpful to understand how the components of the market-to-book ratio are calculated. Below is an overview, including how to use the market-to-book ratio when evaluating stocks. A high P/B ratio suggests a stock could be overvalued, while a lower P/B ratio could mean the stock is undervalued.

The book-to-market ratio identifies undervalued or overvalued securities by taking the book value and dividing it by the market value. The ratio determines the market value of a company relative to its actual worth. Investors and analysts use this comparison ratio to differentiate between the true value of a publicly traded company and investor speculation. This valuation metric compares a stock’s market value to its book value, which is the value of its assets minus its liabilities. High-growth companies often show price-to-book ratios well above 1.0, whereas companies facing financial distress occasionally show ratios below 1.0. Another valuable tool is the price-to-sales ratio, which shows the company’s revenue generated from equity investments.

Wrapping Up – Market to Book Ratio

Depending on the sector a company is in, lower or higher P/B ratios may be the norm. At the same time, companies can boost or lower their cash reserves, which, in effect, changes book value but with no change in operations. For example, if a company chooses to take cash off the balance sheet, placing it in reserves to fund a pension plan, its book value will drop. Share buybacks also distort the ratio by reducing the capital on a company’s balance sheet.

The P/B ratio is an easy calculation, and it’s published in the stock summaries on any major stock research website. Ultimately, firms with high unaccountable intangible assets will tend to have high Market to Book ratios. On another note, stocks whose market to book ratio is greater than 1 tend to be seen as growth stocks. The Market-to-Book Ratio (M/B) or Price-to-Book Value (P/B) is one of the crucial ratios in the field of finance and investment.

1. In contrast, video game companies, fashion designers, or trading firms may have little or no book value because they are only as good as the people who work there.
2. A ratio above 1 indicates that the stock price of a company is trading for less than the worth of its assets.
3. The book value of equity, in turn, is the value of a company’s assets expressed on the balance sheet.
4. This could be due to temporary setbacks or market overreactions to short-term challenges, offering a chance for investors to capitalize on potential price corrections.
5. By multiplying those two metrics, we can calculate our company’s market capitalization, which comes out to be approximately $2.1 trillion.

For example, growth companies often have a higher P/B ratio than mature companies. The book value of equity, also known as the shareholders’ equity, includes the retained earnings and any other accounting adjustments made to book equity along with the paid-in capital. Goodwill impairment is an accounting term used to describe a reduction in the value of goodwill on a company’s balance sheet. The terms are often used interchangeably, though M/B generally refers to the overall company value (market cap versus book value) while P/B can also apply at the per-share level. Yes, a low M/B ratio could suggest a lack of investor confidence, possibly due to concerns over the company’s profitability or market position. However, it’s important to consider the larger context when analyzing the market-to-book ratio, digging deeper into a company’s performance before making any investment decisions.

Formula and Calculation of the Price-to-Book (P/B) Ratio

To a large extent, any changes in these fundamental variables will explain the ratio and must be considered while concluding if the stock is undervalued or overvalued. A low market to book ratio might suggest undervaluation, presenting an opportunity for value investors. This could be due to temporary setbacks or market overreactions to short-term challenges, offering a chance for investors to capitalize on potential price corrections. Tools like Bloomberg Terminal or FactSet can help investors explore qualitative aspects not obvious from the ratio alone.

Unfortunately, accounting does not capture any of these incredibly valuable assets. An alternative interpretation sees the Market to Book ratio as a proxy for determining if a stock is a growth stock or a value stock. And so when you look at a Book Value of Equity and compare that to the Market Price of the stock, you can’t – and certainly shouldn’t – conclude that the stock is under or overvalued. The problem with this is that, as we said earlier in this post, accounting doesn’t really reflect the economic reality. Some people see the Market to Book ratio as a determinant of whether a stock is under or overvalued. Because of the way accounting works, the values that you see on a Balance Sheet, for instance, are not necessarily representative of the economic reality.

At a high level, a ratio below one may market to book ratio indicate that a stock is very cheap, while a high ratio, such as over three, may suggest that it is expensive.