Definition of the book-to-market ratio

What is the book to market ratio?

The book-to-market ratio is an indicator of a company’s value. The ratio compares a company’s book value to its market value. A company’s book value is calculated by looking at the company’s historical cost or book value. A company’s market value is determined by its share price in the stock market and the number of shares outstanding, which is its market capitalization.

Understand the book-to-market ratio

The book-to-market ratio compares a company’s book value to its market value. Book value is the value of assets less the value of liabilities. A company’s market value is the market price of one of its shares multiplied by the number of shares outstanding. The book-to-market ratio is a useful indicator for investors who need to gauge a company’s worth.

The formula for the book-to-market ratio is as follows:

Book to market

=

share capital of the shareholders

market capitalization

text{Book-to-Market}=frac{text{Common Stock}}{text{Market Capitalization}} Book to market=market capitalizationshare capital of the shareholders​

What does the book-to-market ratio tell you?

When a company’s market value is trading higher than its book value per share, it is considered overvalued. If the book value is higher than the market value, analysts consider the company to be undervalued. The book-to-market ratio is used to compare a company’s net asset value or book value to its current or market value.

A company’s book value is its historical cost or book value calculated from the company’s balance sheet. Book value can be calculated by subtracting total liabilities, preferred stock, and intangible assets from a company’s total assets. In fact, book value represents how much assets a company would have had left if it had gone out of business today. Some analysts use all equity on the balance sheet as book value.

The market value of a publicly traded company is determined by calculating its market capitalization, which is simply the total number of shares outstanding multiplied by the current share price. Market value is the price investors are willing to pay to buy or sell the stock in the secondary markets. As it is determined by supply and demand in the market, it does not always represent the real value of a company.

How to use the book to market ratio

The book-to-market ratio identifies under- or overvalued securities by dividing book value by market value. The ratio determines a company’s market value relative to its actual value. Investors and analysts use this comparative ratio to distinguish between the true value of a publicly traded company and investor speculation.

Basically, if the ratio is above 1, the stock is undervalued. If it is below 1, the stock is considered overvalued. A ratio above 1 indicates that a company’s share price is trading below the value of its assets. A high ratio is favored by value managers, who interpret it to mean that the company is a value stock — meaning it’s trading cheaply in the market compared to its book value.

A book-to-market ratio below 1 implies that investors are willing to pay more for a company than its net assets are worth. This could indicate that the company has healthy future earnings prospects and investors are willing to pay a premium for that possibility. Technology companies and other companies in industries that don’t have many physical assets tend to have low book-to-market ratios.

Difference between book to market ratio and market to book ratio

The market-to-book ratio, also known as the price-to-book ratio, is the inverse of the book-to-market ratio. Like the book-to-market ratio, it attempts to assess whether a company’s stock is over- or undervalued by comparing the market price of all outstanding shares to the company’s net worth.

A market-to-book ratio above 1 means the company’s stock is overvalued. A ratio below 1 indicates it may be undervalued; The reverse is the case with the book-to-market ratio. Analysts can use both metrics to compare a company’s book value and market value.