What It Measures
Market/book ratio, sometimes called price-to-book ratio, is a way of measuring the relative value of a company compared to its stock price or market value.
Why It Is Important
Market/book ratio is a useful way of measuring your company’s performance and making quick comparisons with competitors. It is an essential figure to potential investors and analysts because it provides a simple way of judging whether a company is under or overvalued. If your business has a low market/book ratio, it’s considered a good investment opportunity.
How It Works in Practice
At its most simple, market/book ratio measures the market capitalization (expressed as price per stock) of a business divided by its book value (the value of assets minus liabilities). The book value of a company refers to what would be left if the business paid its liabilities and shut its doors, although, of course, a growing business will always be worth more than its book value because it has the ability to generate new sales.
To calculate market/book ratio, take the current price per stock and divide by the book value per stock:
Market/book ratio = Market price per stock ÷ Book value per stock
For example, Company A might be trading at $2.20 per stock. However, the book value per stock is actually $3.00. This results in a market/book ratio of 0.73, suggesting the company’s assets may in fact be undervalued by 27%.
Market-to-book value can alternatively be calculated as follows:
Market/book ratio = Market price per stock ÷ Net asset value per stock
Tricks of the Trade
Like the price-to-earnings ratio, the lower the price-to-book ratio or market/book ratio, the better the value. Investors would use a low price-to-book ratio on stock screens, for instance, to identify potential candidates for new investment. As a rule of thumb, a market/book ratio above one suggests the company is undervalued, while a ratio over one suggests the company might be overvalued.
A low market/book ratio could suggest a company’s assets are undervalued, or that the company’s prospects are good and earnings/value should grow.
Market/book ratios are most useful when valuing knowledge-intensive companies, where physical assets may not accurately or fully reflect the value of the business. Technology companies and other businesses that don’t have a lot of physical assets tend to have low book-to-market ratios.