Market/Book Ratio

The ratio of the current market price to the book value of the each share is called as market / book ratio. It measures the worthiness of the company with respect to the amount of capital invested by the current and the past share holders. Book value is calculated by comparing the firm’s price history. Book value can also be termed as the value of the company if all the liabilities are paid and the business is shut. Market value is determined by finding its capitalization.  The main usage of this ratio is to identify whether the stock is over valued or under valued in order to make financial decision. If the ratio is low then it is considered as a good investment opportunity. This analysis are done mainly in service oriented companies where analyzing the physical asset is not possible.

Market / Book ratio = Market value of the company/ Book value of the company.

The importance of this ratio varies with industry. Industry with a very high capital requirement (steel industry) will have a very high market/ book ratio whereas industry with low capital requirements (software) will have a very low market / book ratio. If the market / book ratio is higher then the investor will be expecting a higher return from the asset. Market / book ratio however does not show the profit making ability of the company. The only thing that the investor can understand from this ratio is that, what will happen to the investor if the company goes bankrupt. It is often calculated leaving aside the intangible asset and good will associated with the company. Since the intangible asset includes intellectual property right and brand value it will not suit some of the companies. It is often termed as PB ratio.

Market value of the stock is not fixed, it keeps on changing. In order to find the PB ratio the average market value of the stock is determined. The ratio can be used by the investor to some extend, however too much of dependence on this calculation for making investment decision are not correct, this is because it has not taken intangible asset into consideration, goodwill are also not taken into consideration.

Questions

• What is book value of a company?
• What is the need to calculate PE ratio?