Book-to-Market Ratio
The book-to-market ratio compares a company’s accounting (book) value to its market value to help assess whether a stock may be undervalued or overvalued.
What it measures
- Book value (shareholders’ equity) = total assets − total liabilities (sometimes excluding preferred shares and certain intangibles, depending on the analyst).
- Market value (market capitalization) = current share price × shares outstanding.
- The ratio shows how much of the company’s accounting equity is represented by its market price.
Formula and calculation
- Basic formula:
Book-to-Market = Common Shareholders' Equity / Market Capitalization - In practice:
- Take the company’s shareholders’ equity from the latest balance sheet.
- Compute market cap (share price × shares outstanding).
- Divide equity by market cap.
Example:
– Shareholders’ equity = $500 million
– Market cap = $1,000 million
– Book-to-market = 500 / 1,000 = 0.5
How to interpret the ratio
- Ratio > 1.0: Market value is less than book value — stock may be undervalued (value stock).
- Ratio < 1.0: Market value exceeds book value — stock may be valued for growth or intangible assets; could be overvalued on a book-value basis.
- These are signals, not proofs. Industry norms and business models affect what is “high” or “low.”
Practical uses
- Screening: Identify potential value stocks (high book-to-market) or growth/asset-light companies (low book-to-market).
- Relative valuation: Compare companies within the same industry where asset intensity and accounting treatments are similar.
- Historical research: Used in academic studies of value vs. growth returns.
Book-to-Market vs. Price-to-Book
- Price-to-book (P/B) is the inverse of book-to-market:
Price-to-Book = Market Cap / Shareholders’ Equity(orShare Price / Book Value per Share) - Both convey the same information; one emphasizes market price relative to book (P/B), the other book relative to market (book-to-market).
Limitations and caveats
- Accounting differences: Different accounting policies, write-downs, and depreciation methods affect book value.
- Intangible and human capital: Firms with few physical assets (tech, services) often show low book values that understate economic value.
- Timing: Balance-sheet figures are periodic; market prices change constantly.
- One metric among many: Use alongside earnings, cash flows, growth prospects, leverage, and industry context.
Key takeaways
- The book-to-market ratio is a simple tool to compare accounting equity with market valuation.
- Values above 1 may indicate undervaluation; values below 1 may reflect market premium for growth or intangibles.
- Interpret within industry norms and alongside other financial measures to form a complete view.