A key indicator of your business’ overall value, it’s worth keeping an eye on the book to market ratio. Learn everything you need to know about the market to book / book to market ratio.
Market to book ratio definition
The market to book ratio is a metric that compares your business’s book value to its market value. This is determined by its current price on the stock market and any outstanding shares it may have. The book to market ratio works in the same way in reverse, but can be used to determine the same thing: the overall value of your company. Both ratios may be used by analysts or investors to decide if your business is overvalued, or undervalued.
What is book value and market value?
To understand the market to book ratio, you need to determine two figures. First is the book value of your business, and second is the market value.
Determining book value
Book value refers to the value of all your businesses assets which have been divided by the total value of your liabilities. If the business were to fail today, the book value is essentially what you would be left with in assets. Sometimes the shareholder equity will be used as book value.
Determining market value
The market value of a company is worked out using its current share prices. One share price is multiplied by the total of outstanding shares to give you market value. This figure is based on what investors are willing to buy and sell at, so it will change depending on supply and demand. That means it may not always be completely accurate in showing actual company value.
Calculating the market to book value
Once you have these figures, you can use the following formula, or an online market to book ratio calculator, to find out your company’s market to book ratio:
Book to Market Ratio = (Share Price x Outstanding Shares) / Book Value
For example, if your business has a share price of $4, and has 700,000 outstanding shares, and a book value, in accordance with your balance sheet, of $1,400,000, your calculations would be:
(4 x 700,000) / 1,400,000 = 2
What should the book to market factor be?
Generally, the results of your book to market ratio should be around 1. Less than 1 implies that a company can be bought for less than the value of its assets. A higher figure of around 3 would suggest that investing in a company will be expensive. However, this may also be because they are expected to do well in the future.
Is the market to book ratio accurate?
As with most finance equations and predictions, the book to market factor can only serve as guidance. Some businesses, for example, don’t need a lot of assets in order to be profitable, and the market to book ratio may not reflect this. It also doesn’t take into account things like intangible assets or prospective earnings growth. That means certain businesses may be very underrepresented by the market to book ratio.
Generally, the market to book ratio is used to determine if a company is over or undervalued, but shouldn’t be used as a sole metric to guide investment decisions.
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