- Valuation
Step-by-Step Guide to Understanding Market to Book Ratio (M/B)
Last Updated December 6, 2023
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What is Market to Book Ratio?
TheMarket to Book Ratio compares a company’s market capitalization, or “equity value,” to its book value of equity (BVE).
Table of Contents
- How to Calculate Market to Book Ratio?
- Market to Book Ratio Formula
- What is a Good Market to Book Ratio?
- Market Value vs. Book Value of Equity (BVE): What is the Difference?
- Market to Book Ratio Calculator
- Market to Book Ratio Calculation Example
How to Calculate Market to Book Ratio?
The market to book ratio, also known as the price-to-book ratio (or P/B ratio), measures a company’s market capitalization relative to its book value of equity (BVE), which is the recorded value of its shareholders’ equity for bookkeeping purposes.
The two components of the market to book ratio are the following metrics:
- Market Capitalization →The market cap of a company, otherwise known as the “equity value”, is determined by multiplying the latest closing share price of a company by the total number of shares outstanding. The share count calculation should be on a fully diluted basis, since dilutive securities such as options, warrants, and convertible securities can create additional shares (and dilute the existing ownership structure). The share price of the company is constantly fluctuating based on current investor sentiment, so the market cap reflects how much investors in the market estimate the company’s equity to be worth, as of the present date.
- Book Value of Equity (BVE) →In contrast, the book value of equity (BVE) is an accounting metric calculated for purposes of bookkeeping, i.e. the “Shareholders’ Equity” section of the balance sheet. With the fundamental accounting equation in mind (Assets = Liabilities + Equity), the book value of equity equals the net difference between the carrying value of a company’s total assets and its total liabilities. Thus, the book value of equity can be thought of as the residual value left for shareholders if the company were to undergo a liquidation and the proceeds were used to settle all the company’s outstanding liabilities (e.g. debt, accounts payable).
Market to Book Ratio Formula
The market to book ratio formula is as follows.
Market to Book Ratio =Market Capitalization÷Book Value of Equity (BVE)
Conversely, the market to book ratio can be calculated using the same metrics, expressed on a per-share basis.
Market to Book Ratio =Market Share Price÷Book Value of Equity Per Share (BVPS)
What is a Good Market to Book Ratio?
The ratio between a company’s market cap to its book value of equity can be useful for investors in determining whether a company is undervalued, overvalued, or fairly priced.
But of course, the market to book ratio cannot be used as a standalone metric and must be used in conjunction with various other financial ratios to support an investment thesis.
- Higher Market-to-Book Ratio →A company trading at a substantially higher share price (and thus a higher market cap) relative to its book value of equity might be trading at a premium over its intrinsic value. Still, a higher ratio does not necessarily mean the company is overvalued by the market and is a candidate for a short position. Instead, it could simply mean that investors are optimistic about the company and its future growth prospects (e.g. Apple, Amazon, Tesla).
- Lower Market-to-Book Ratio →On the other hand, if a company’s market cap has fallen recently to trade close its book value of equity (BVE), the steep decline observed in its valuation was likely warranted, which tends to be a troubling sign as such declines rarely occur without reason. Yet, opportunistic investors often attempt to capitalize from these sorts of scenarios, as the market could have overreacted to the negative news (i.e. oversold) and the company will soon implement drastic measures to turn its downward trajectory around. In other words, the drop-off in valuation can be viewed as an opportunity to purchase shares in the company by certain value-oriented investors, especially if a turnaround seems feasible and the recent sell-off might have been overdone.
Market Value vs. Book Value of Equity (BVE): What is the Difference?
The market value of equity is a function of a company’s share price, which is actively traded in the open markets, with forward-looking assumptions regarding the company’s outlook priced in.
Barring unusual circ*mstances, the market value of a publicly traded company’s equity is greater than its book value of equity in most cases unless the company is in a state of financial distress and/or on the verge of filing for bankruptcy protection.
In fact, the practicality of the market to book ratio tends to be limited to being used as a screening tool to identify potentially undervalued companies prior to performing more in-depth diligence on the company’s fundamentals, the relevant industry or secular trends, and other factors that can impact its share price.
Because the book value of equity (BVE) is a “levered” metric (i.e. post-debt) that pertains only to the equity holders, the corresponding metric to use in the ratio is the market capitalization as opposed to the enterprise value. Otherwise, there would be a mismatch between the group of capital provider(s) represented.
Market to Book Ratio Calculator
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Market to Book Ratio Calculation Example
Suppose you’re tasked with calculating the market to book ratio of Apple (NASDAQ: AAPL) using the following assumptions.
- Latest Closing Share Price (12/30/22) = $129.93
- Total Number of Diluted Shares Outstanding (mm) = 15,908
By multiplying those two metrics, we can calculate our company’s market capitalization, which comes out to be approximately $2.1 trillion.
- Market Capitalization = $129.93 × 15,908 million = $2,067 billion
In the next step, we’ll calculate Apple’s book value of equity (BVE) by subtracting its total liabilities from its total assets, per its latest reported balance sheet for fiscal year ending 2022.
- Total Assets ($mm) = $352,755
- Total Liabilities ($mm) = $302,083
The difference between total assets and total liabilities is $50,672 million, which represents Apple’s book value of equity (BVE).
- Book Value of Equity (BVE) = $352,755 million ÷ $302,083 million = $50,672 million
Note that the calculation can be adjusted to include the value of only tangible assets, i.e. excluding intangible assets such as goodwill.
But for the sake of simplicity, we’ll calculate our market to book ratio without any adjustments.
Upon dividing Apple’s market cap by its book value of equity (BVE), we arrive at a market to book ratio of 40.8x.
- Market to Book Ratio = $2,067 billion ÷ $50,672 million = 40.8x
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