Title: Book-to-Market Ratio — what it is, how to compute it, and how to use it
Definition
– Book-to-market ratio = company book value divided by market capitalization.
– Book value (also called shareholders’ equity) is the accounting measure of a company’s assets less its liabilities (and sometimes adjusted to remove preferred equity and intangible assets, depending on the analyst). Market capitalization (market cap) = share price × shares outstanding.
– The ratio expresses how the market prices the company relative to its accounting net worth.
Formulae (two equivalent forms)
– Book-to-Market = Common Shareholders’ Equity / Market Capitalization
– Book-to-Market (per share) = Book Value per Share / Market Price per Share
Note: Book Value per Share = (Shareholders’ Equity − preferred equity − chosen adjustments) / Shares Outstanding.
Step-by-step calculation
1. Get the latest balance sheet and note total assets and total liabilities (and any preferred stock or intangibles you plan to exclude).
2. Compute book value (shareholders’ equity) = total assets − total liabilities (adjust if you remove preferred shares or intangibles).
3. Find current share price and shares outstanding; compute market cap = price × shares outstanding.
4. Divide book value by market cap (or divide book value per share by market price).
5. Interpret result in context (industry, accounting policies, growth expectations).
Worked numeric example
– Company A balance sheet: total assets = $500 million; total liabilities = $300 million. Shareholders’ equity = 500 − 300 = $200 million.
– Shares outstanding = 20 million. Current share price = $8. Market cap = 20,000,000 × $8 = $160 million.
– Book-to-Market = 200,000,000 / 160,000,000 = 1.25.
– Interpretation: The accounting equity exceeds market value (ratio > 1). Some investors would call this a candidate “value” stock; others would investigate reasons the market is pricing it below book (e.g., weak earnings prospects, off‑balance items).
How to read the ratio
– Ratio > 1: market prices the company below its accounting net assets (often interpreted as undervaluation, subject to further investigation).
– Ratio < 1: market values the company above its accounting net assets (may reflect strong growth expectations, valuable intangibles, or superior profitability).
– The inverse metric is the market-to-book (or price-to-book) ratio = 1 / (book-to-market), commonly used as well.
Common uses and who finds it useful
– Value investors use it to screen for stocks selling below accounting net worth.
– Analysts use it to compare relative valuations across firms in the same industry.
– It’s often a component of academic tests of value vs. growth strategies.
Limitations and cautions
– Accounting measures vary across firms and over time (different depreciation, impairment, or capitalization rules), so book value is not a pure economic measure.
– Intangible-heavy firms (software, biotech, brands) often have low book value relative to market value; a low book-to-market does not automatically mean overvaluation.
– One-time charges, off-balance-sheet items, recent M&A, or large buybacks can distort both numerator and denominator.
– Always use it together with profitability, cash flow, growth prospects
– How to calculate
– Formula (per share): Book-to-Market Ratio = Book Value per Share / Market Price per Share.
– Formula (aggregate): Book-to-Market Ratio = Total Shareholders’ Equity / Market Capitalization.
– Alternate names: The inverse is Price-to-Book (P/B) = Market Price / Book Value; P/B = 1 ÷ (Book-to-Market) when both use the same per‑share or aggregate basis.
– Practical note on inputs: use the latest reported shareholders’ equity (balance-sheet total) and the market price at a defined date. If comparing across firms, make sure currency, reporting date, and share counts (basic vs. diluted) are consistent.
– Worked numeric example
– Step 1 — get the numbers: Company A reports shareholders’ equity of $2,500 million and has 200 million shares outstanding. Current market price = $18.00 per share.
– Step 2 — compute book value per share (BVPS): BVPS = $2,500 million / 200 million = $12.50.
– Step 3 — compute book-to-market: B/M = BVPS / Price = $12.50 / $18.00 = 0.694 (or 69.4%).
– Interpretation: A B/M of 0.694 means the market values the firm at about 0.694 times its accounting book value. Many practitioners would classify this as relatively “valuey” compared with a firm with B/M = 0.1, but context matters (industry norms, intangibles).
– Step-by-step checklist for practical use
1. Confirm the date alignment: use book value from the latest balance sheet and the market price at a chosen date (e.g., quarter-end).
2. Decide per-share vs. aggregate: use the same basis for all comparisons.
3. Check for nonrecurring items: large write-downs, restructuring charges, or recent M&A may distort book equity.
4. Consider intangibles: for asset-light firms, compute tangible book (equity minus goodwill and other intangibles) and compare both measures.
5. Compare to peers and historical percentiles within the industry.
6. Use alongside profitability (ROE), cash flow, leverage, and growth estimates before drawing conclusions.
– Common variations and how to use them
– Tangible Book-to-Market: (Shareholders’ Equity − Intangibles) / Market Cap. Useful for banks, manufacturing, or where goodwill materially inflates reported equity.
– Market-to-Book (inverse): Market Cap / Book Equity. Often used when discussing “market premium” over accounting value.
– Book-to-Market on a rolling or average basis: averaging book equity over several periods can smooth distortions from one-time events.
– Sector adjustments: calculate median B/M for the industry and express company B/M as a percentile or ratio to that median.
– Empirical and academic context (brief)
– The book-to-market ratio features prominently in empirical asset pricing. Fama and French found that higher book-to-market firms historically delivered higher average returns than low book-to-market firms after controlling for market beta and size. This is an empirical observation, not a prediction, and it does not guarantee future outperformance.
– Use academic findings as background for hypothesis generation rather than mechanical rule-following.
– Practical pitfalls and assumptions to state explicitly
– Assumption: accounting equity reflects historical cost-based measures and may not equal liquidation or replacement value.
– Pitfall: intangible-intensive businesses (software, biotech, brands) often show low book values; low B/M may be normal and not a sign of overvaluation.
– Pitfall: differences in accounting standards (US GAAP vs. IFRS), depreciation, and capitalization policies can make cross-border comparisons misleading.
– Always verify that share counts reflect dilution if you’re comparing per-share measures across firms.
– How traders and analysts typically use it
– Screening: find candidates with high B/M relative to sector peers for deeper fundamental analysis.
– Factor models: included as a “value” factor in multi-factor strategies; often combined with size, momentum, and profitability factors.
– Valuation sanity check: compare market valuation implied multiples with the accounting base as a cross-check, not a sole decision metric.
Sources and further reading
– Investopedia — Book-to-Market Ratio: https://www.investopedia.com/terms/b/booktomarketratio.asp
– Fama, E.F. & French, K.R. — The Cross-Section of Expected Stock Returns (1992): https://www.jstor.org/stable/2329112 (Journal of Finance) and data library: https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
– U.S. Securities and Exchange Commission — Balance Sheets and Financial Statements (Investor.gov): https://www.investor.gov/introduction-investing/investing-basics/how-to-read-financial-statements
Educational disclaimer
– This information is educational and not personalized investment advice. It
is not financial, tax, or legal advice. Consult a licensed professional before making investment decisions.
Quick checklist when using the book-to-market (B/M) ratio
– Confirm definitions: use “book value” = total common shareholders’ equity (or book value per share) and “market” = current market price per share (or market capitalization).
– Match dates: book value comes from the balance sheet date; use the market price at the same or proximate date.
– Adjust for capital structure: exclude preferred equity if you want common-equity B/M; be explicit about treatment of minority interests.
– Watch accounting distortions: large intangibles, recent write‑offs, or aggressive accounting can skew book values.
– Compare peers and sectors: interpret B/M relative to industry norms and firm life cycle (cyclical vs. growth).
– Use it as one input: combine with profitability, growth, cash flow, and qualitative analysis.
Worked numeric example
– Given: total common shareholders’ equity = $200 million; shares outstanding = 20 million; market price = $15.00 per share.
– Book value per share = 200,000,000 / 20,000,000 = $10.00.
– B/M = book value per share / market price = 10 / 15 = 0.6667 (or 66.67%).
– Equivalent using totals: market capitalization = 20,000,000 × 15 = $300 million; B/M = 200 / 300 = 0.6667.
Interpretation: a B/M above 1.0 often signals the stock trades below book value; below 1.0 may indicate market expects future profitability or intangible value not on the balance sheet. Interpret cautiously.
Limitations and common pitfalls
– Negative book values: ratio becomes non‑informative or misleading if book equity is negative.
– Intangible-heavy firms: software, biotech, or brands may have low B/M despite strong economic value.
– Cyclicality: firms in cyclical industries can show temporarily high B/M during downturns.
– Accounting policy differences: GAAP vs. IFRS and firm-specific estimates can affect comparability.
Further reading (selected)
– Investopedia — Book-to-Market Ratio: https://www.investopedia.com/terms/b/booktomarketratio.asp
– Fama, E.F. & French, K.R. — The Cross-Section of Expected Stock Returns (1992): https://www.jstor.org/stable/2329112
– Fama–French Data Library (factor data and research resources): https://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html
– U.S. Securities and Exchange Commission — How to Read Financial Statements (Investor.gov): https://www.investor.gov/introduction-investing/investing-basics/how-to-read-financial-statements
Educational disclaimer
This material is educational and general in nature; it does not constitute individualized investment, tax, or legal advice. For decisions that affect your financial situation, consult a qualified professional.