Market to Book Ratio

The market to book ratio is the ratio between the company’s current (or year-end) market price per common share of stock and its book value per share as of the same date. The market to book ratio is also called the price to book ratio.

The market to book ratio will generally be greater than 1.0 if the market expects abnormally high earnings in the future; however, it will be lower than 1.0 if the market expects abnormally low earnings in the future.

Furthermore, the market to book ratio should be greater than 1.0 because of the way fixed assets are accounted for under U.S. GAAP. Whereas the market price of a share of stock is a good approximation of its fair value, the book value of a share represents only its share of the issuing entity’s accounting assets minus its accounting liabilities. Since assets that appreciate in value are not written up in the accounting records under U.S. GAAP, a share’s fair value should be greater than its book value. An “unadjusted” book value per share (see discussion in the previous topic, Book Value Per Share) is used by some analysts as an “index” against which to compare the market price of the stock. Assuming that the ratio between market price and book value per share should be similar for firms in the same industry, the analyst determines whether the ratio between them for a given firm is in line with that of the industry.

The ratio between market value and adjusted book value (as described in the previous topic) may be used to screen for underpriced stocks. If the market price is below or very close to the adjusted book value per share, the stock may be a good buy at its current market price.

A market price that is lower than the adjusted book value is often a predictor of a takeover or merger, as the firm may be considered a bargain by other firms. Of course, that determination must be made in the context of the firm’s overall financial condition. A company on the verge of bankruptcy may be trading at a market price that is significantly below its book value per share (adjusted or unadjusted), but that does not mean the stock or the company is a good buy