What is the Market-to-Book Ratio?
The market-to-book (M/B) ratio, also called the price to book (P/B) ratio, is a valuation model used to determine the current market value of a company (derived from the stock price) compared to its book value (derived from assets and liabilities).
You can determine the market-to-book ratio by dividing the closing price of the stock by the book value per share.
What is book value?
Book value is what’s in the accounting books. In other words, book value is the net value of a company's total assets after deducting all its liabilities.
Total assets refers to both tangible and intangible assets. Tangible assets include all financial and physical assets, such as cash, accounts receivables, properties, and equipment. Intangible assets include intellectual property rights, brand name, and logo. All liabilities include accounts payables, taxes, and debts.
It’s a simple calculation:
Book value = total assets - total liabilities
If a company is liquidated, book value is the amount stockholders would receive after paying off the company's debts and other financial obligations.
You can find a company’s book value in its balance sheet through its total assets and liabilities. You can also find it under the shareholders' equity.
What is market value?
Market value, also known as market cap, shows a company's value in the stock market. It’s the price investors believe the company is worth. You can calculate market value by multiplying the total outstanding shares of the company with the current market share price.
Market value = outstanding shares x stock price
The company's market value changes continuously based on its stock movement in the market. In other words, a company's market value rarely stays the same for long.
The market value is often higher than the company's book value, because investor emotions often play a role in stock prices. When there is a lot of news, excitement, or anger for a given company, the market price rises and falls in response even though the book price may not be affected in any way. Despite this, most investors base their investment decisions on the market value.
Likewise, when reporters or financial analysts talk about a company's value, they’re usually referring to its market value at a given point in time. Because the market is sometimes volatile, it does not necessarily show the full picture with a company's assets and liabilities.
Determining and interpreting the market-to-book ratio
The market-to-book (M/B), or price-to-book (P/B), ratio is used by investors to show how the market perceives the value of a particular stock. It is also used to compare the net assets of a company in terms of the current price of its stock.
The formula for this is:
Market-to-book ratio = current stock price / total book value
If the M/B ratio is equal to 1, the market and book value are the same. If the market price were to drop below book value, the ratio would be less than 1, and it would indicate a problem.
When the M/B ratio is below 1, the company is either undervalued or it is having problems. Sometimes this happens due to legal reasons, legislation, or because of a change in leadership. Sometimes it’s simply because investors have lost confidence in the company.
How does the market-to-book ratio help you?
While the market-to-book ratio helps many investors decide which stocks to buy, it should not be the only deciding factor. Some companies have higher or lower ratios because they don’t have a lot of tangible assets. They may have human assets or intellectual property instead. Others are valued more because of their profitability or their core values.
The market-to-book ratio is most helpful when you want to compare companies within the same industry. It’s also quite useful when looking for undervalued investments that may have more potential to grow.