Book-to-market ratio

Definition

The book-to-market (B/M) ratio is a financial metric used to evaluate the relative valuation of a company’s stock by comparing its book value to its market value. 

What is a book-to-market ratio?

The book-to-market ratio provides insight into the valuation of a company’s stock relative to its accounting value. A high book-to-market ratio suggests that the company’s stock is relatively undervalued by the market compared to its book value, while a low ratio indicates that the stock may be overvalued.

The book-to-market ratio is calculated by dividing a company’s book value per share by its market value per share. The formula is as follows:

B/M ratio = Book value per share / Market value per share

The book value per share is typically derived from the company’s balance sheet by dividing its total shareholders’ equity by the number of outstanding shares. The market value per share is obtained by multiplying the current market price per share by the number of outstanding shares.

While the book-to-market ratio provides valuable insights into a company’s valuation, it has some limitations. For example, it does not take into account future earnings potential, growth prospects, or qualitative factors that may impact a company’s stock price. 

Difference between the book-to-market ratio and the market-to-book ratio

The book-to-market ratio (B/M) and the market-to-book ratio (M/B) are both financial metrics used to evaluate the relationship between a company’s book value and its market value, but they approach this relationship from different perspectives.

The book-to-market ratio calculates the ratio of a company’s book value to its market value. A high B/M ratio suggests that the company’s stock is undervalued relative to its book value, implying potential value for investors.

Conversely, the market-to-book ratio is the opposite of the B/M ratio. It measures the ratio of a company’s market value to its book value, indicating how the market values the company’s assets relative to their accounting value. A high M/B ratio indicates that investors are willing to pay more for the company’s assets than their book value, which may suggest market confidence in future growth prospects or intangible assets not reflected on the balance sheet.

Example of a book-to-market ratio

Let’s consider a company, ABC Inc., which has the following financial information:

• Book value per share: $20
• Market value per share: $30

To calculate the book-to-market ratio for ABC Inc., we use the formula from above:

B/M ratio = $20 / $30 = 0.67

In this example, the book-to-market ratio for ABC Inc. is 0.67. This means that for every dollar of book value, the market values the company at $0.67. A ratio less than 1 indicates that the market values the company lower than its book value, suggesting that the stock may be seen as undervalued by the market compared to its accounting value.