## Market Value Ratios

After reading this section, you will have been exposed to the different types of market value ratios, their formulas, how to compute them, and which financial statements contain the information needed to calculate the ratios. You will also learn how to interpret the ratios and apply those interpretations to understanding the firm's activities.

The price-to-book ratio is a financial ratio used to compare a company's current market price to its book value.

#### LEARNING OBJECTIVE

• Calculate the different types of price to book ratios for a company

#### KEY POINTS

• The calculation can be performed in two ways: 1) the company's market capitalization can be divided by the company's total book value from its balance sheet, 2) using per-share values, is to divide the company's current share price by the book value per share.
• A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal.
• Technically, P/B can be calculated either including or excluding intangible assets and goodwill.

#### TERM

• outstanding shares

Shares outstanding are all the shares of a corporation that have been authorized, issued and purchased by investors and are held by them.

#### Price/Book Ratio

The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market price to its book value. The calculation can be performed in two ways, but the result should be the same either way.

In the first way, the company's market capitalization can be divided by the company's total book value from its balance sheet.

• Market Capitalization / Total Book Value

The second way, using per-share values, is to divide the company's current share price by the book value per share (i.e. its book value divided by the number of outstanding shares).

• Share price / Book value per share

As with most ratios, it varies a fair amount by industry. Industries that require more infrastructure capital (for each dollar of profit) will usually trade at P/B ratios much lower than, for example, consulting firms. P/B ratios are commonly used to compare banks, because most assets and liabilities of banks are constantly valued at market values.

A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal (and/or that the market value of the firm's assets is significantly higher than their accounting value). P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.

This ratio also gives some idea of whether an investor is paying too much for what would be left if the company went bankrupt immediately. For companies in distress, the book value is usually calculated without the intangible assets that would have no resale value. In such cases, P/B should also be calculated on a "diluted" basis, because stock options may well vest on the sale of the company, change of control, or firing of management.

It is also known as the market-to-book ratio and the price-to-equity ratio (which should not be confused with the price-to-earnings ratio), and its inverse is called the book-to-market ratio.

#### Total Book Value vs Tangible Book Value

Technically, P/B can be calculated either including or excluding intangible assets and goodwill. When intangible assets and goodwill are excluded, the ratio is often specified to be "price to tangible book value" or "price to tangible book".