What is Market to Book Ratio?
The term “Market to Book ratio” refers to the financial valuation metric that is utilized in the evaluation of the current market value of a company relative to its book value. The market value of a company stock basically refers to the current stock price of all its outstanding shares.
On the other hand, the book value of a company is the net amount left in case the company liquidates all of its assets and repay all of its liabilities.
Formula
The calculation can be done in two ways –
This ratio can be calculated by dividing the market value of the stock by the book value per share of the company. Mathematically, it is represented as,
1) Market to Book Ratio formula = Market value of stock / Book value per share
On the other hand, it can also be calculated by dividing the market capitalization by the total book value or tangible net worth of the company.
The Formula is represented as,
Steps to Calculate Market to Book Ratio
The formula calculation is done by using the following steps:
Step 1: Firstly, collect the current market value of the stock which is easily available from the stock market. Now, collect the number of outstanding shares of the company and determine the market capitalization by multiplying the current stock price and the number of outstanding shares.
Market capitalization = Current stock price * Number of outstanding shares
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Step 2: Next, determine the total book value or the net worth of the company from its balance sheet. Net worth can be computed by deducting total liabilities, preferred stock and intangible assets from total assets of the company.
Total book value = Total assets – Total liabilities – Preferred stock – Intangible assets
Step 3: Finally, the calculation can be completed by dividing the market capitalization by the total book value of the company as shown below.
Market to Book ratio = Market capitalization / Total book value
Examples of Market to Book Ratio (with Excel Template)
Let’s see some simple to advanced examples to understand it better.
Example#1
Let us take the example of David who intends to invest in the furniture company ABC Ltd, which is a publicly traded company. ABC Ltd has 10,000 outstanding shares that are trading at $50 per share. The company reported a net worth of $300,000 on their balance sheet as on the last day of the previous accounting period. Calculate the market to book ratio for ABC Ltd.
Given, Total book value = $300,000
Below is the data for the calculation of ABC Ltd.
Therefore, market capitalization can be calculated as
Market Capitalization = Current stock price * Number of outstanding shares
= $50 * 10,000
Market Capitalization = $500,000
Therefore, the ratio for ABC Ltd can be calculated as,
= $500,000 / $300,000
= 1.67
A ratio of more than one indicates that the investors value the company more than its book value.
Example#2
Let us now take the example of Apple Inc. As on March 1, 2019, the current market value of each share of Apple Inc. stood at $174.97 and 4,745,398,000 number of outstanding shares. The latest reported net worth of the company stood at $118,255,318,160. Calculate the market to book ratio for Apple Inc.
Given, Total book value = $118,255,318,160
Below is data for the calculation of Apple Inc.
Therefore, market capitalization can be calculated as
Market capitalization = Current stock price * Number of outstanding shares
= $174.97 * 4,745,398,000
Market Capitalization = $830,302,288,060
Therefore, the ratio for Apple Inc. can be calculated as,
= $830,302,288,060 / $118,255,318,160
= 7.02
A high ratio simply justifies the investors’ confidence in the brand of Apple Inc. and its future growth prospects.
Market to Book Ratio Calculator
You can use the below Formula Calculator
Interpretation
From the perspective of investors, a formula is a very important ratio because it helps them to decide whether a stock is overvalued or undervalued –
- If the ratio is less than one then it could be indicative of the fact that the stock is undervalued in which case it can be seen as a good investment because the stock price is expected to bounce back.
- If the ratio is greater than one then it could mean that the stock is overvalued in which case it might not be a very good investment because the high price might not be backed by a strong company perspective, although it might not always be true.
However, the formula also has some limitations like most other financial metrics. One of the primary issue with the ratio is that it overlooks the value of intangible assets of a company (such as brand equity, goodwill, patent, etc.), which in today’s world are accepted to be really valuable. As such, the ratio is rarely useful for the valuation of a company that has a significant portion of its assets in intangible assets. Examples of such companies can be IT companies or other knowledge-based companies.
Recommended Articles
This has been a guide to Market to Book Ratio. Here we learn how to calculate Market to Book Ratio using its formula along with examples and interpretation. You can learn more about accounting from the following articles –
