Book to Market Ratio

What is Book to Market Ratio?

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 while the market capitalization is determined based on the price at which the stock is traded. It is computed by dividing the current book value of equity by the market value of equity.

Explanation

Book-to-Market-Ratio

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Source: Book to Market Ratio (wallstreetmojo.com)

Book to Market Ratio Formula

Book to Market Ratio = Book Value of Equity / Market Value of Equity

where,

  • Book value of equity = Based on accounting conventions
  • The market value of equity = Market capitalization (Price * number of shares outstanding)

Example of Book to Market Ratio

You can download this Book to Market Ratio Excel Template here – Book to Market Ratio Excel Template

XYZ Inc., a Nasdaq listed company, is currently trading at $11.25 per share. The firm had a book value of assets of $110 million and a book value of liabilities of $65 million at the end of 2019. Based on the recent filing with the exchange and the SEC, the company has 4 million shares outstandingShares OutstandingOutstanding shares are the stocks available with the company's shareholders at a given point of time after excluding the shares that the entity had repurchased. It is shown as a part of the owner's equity in the liability side of the company's balance sheet.read more. As an analyst, determine the Book-to-Market ratio for XYZ and, assuming everything constant interprets how the ratio influences investment decisions.

Solution

Use the below-given data for calculation of book to market ratio.

ParticularsUS ($)
Book Value of Assets110000000
Book Value of Liabilities65000000
Price Per Share11.25
Number of Shares Outstanding4000000

Calculation of Book & Market Value of Equity

Book to Market Ratio Example 1.1
  • = 110000000-65000000
  • Book Value of Equity = 45000000
  • = 11.25* 4000000
  • Market Value of Equity = 45000000

The calculation can be done as follows,

Example 1.2
  • =45000000/45000000
  • Book Value of Equity = 1.00

When a stock price falls to $10 –

Book to Market Ratio Example 1.3
  • =45000000/40000000
  • Book Value of Equity = 1.13

Calculation when a stock price increases to $20 can be done as follows,

Example 1.4
  • =45000000/80000000
  • Book Value of Equity = 0.56

Interpretation

Conclusion

It is always recommended to use other fundamental variables while interpreting a ratio. These fundamental variables could be growth rate, return on equityReturn On EquityReturn on Equity (ROE) represents financial performance of a company. It is calculated as the net income divided by the shareholders equity. ROE signifies the efficiency in which the company is using assets to make profit.read more, payout ratio, or the expected risk in the company. 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.

Further, the book value is never readily available. For example, if an investor wants the ratio on February 1, 2020, the latest book value for this date will not be available if this not the end of a quarter of the financial year for the company. Another reason which renders this ratio to be less reliable is with respect to how book value is determined. The book value normally ignores the fair value of intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. read more and the growth potential in the earnings, which leads to the risk of estimating a lower book value and hence, the ratio.

Therefore, this ratio is not meaningful when subject companies have huge internally-generated intangibles such as brands, customer relationships, etc. which do not reflect in the book value. It is hence, best suited for companies with real assetsReal AssetsReal Assets are tangible assets that have an inherent value due to their physical attributes. These assets include metals, commodities, land, and factory, building, and infrastructure assets. read more in books such as insurance, banking, REITs, etc. Hence, while making any investment decisions, it is essential to consider other ratios along with the underlying fundamental variables.

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