What is market to book ratio?
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The market to book ratio is a ratio which is used to find the value of the company by comparing the market value of the company to its book value. Book value is calculated on the basis of the firm’s historical cost. The market value is calculated on the basis of the stock market through its market capitalization and how? Finance Shed has answer.
Book value vs. Market value
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The value of firm is assessed in two ways i.e. book value and its market value.
The market value of the company is the value at the time as determined by the financial market place and is the value of the product of the shares price and the total no. of shares outstanding. It is the price that the investors are willing to pay to acquire or sell the securities in the equity markets. As it is the product of share price and its outstanding value it is solely dependent on the market price of the shares which is dependent on the demand and supply of the share on the particular date so it is not representing the actual value of the firm.
The book value is the net value of the assets of the company. The net asset value means the total assets less depreciation less liabilities less intangible asset. So it is the value of the company which is determined so that it can be known that what will be the value of the company if it stops its business today.
How the analyses can be done using market to book ratio:
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The market to book ratio is used to identify undervalued or overvalued securities by applying the formula. It helps us to know the market value of the company relating to its actual worth. So this ratio will be helpful to find out the difference between the true values of the company as well as the value which is determined in the stock exchanges based on the demand and supply. So it is the difference of value which is determined with and without the speculative trading So for the basic analysis the ratio is seen, if the answer of the ratio comes less than 1 then the stock price is undervalued which means that the company’s stock is traded at the lower price than what it should have been traded and if the answer is above 1 then the stock price is overvalued which means that the stock is traded at the higher price than the price it should have been traded.
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The book to market ratio is also available which will be calculated in the exact opposite manner i.e. if the answer for the ratio is above 1 then it will be analyzed as the company’s stock price is undervalued and as against this if the ratio comes to the value less than 1 then the company’s stock price will be considered overvalued. This is the detailed analysis of how to calculate and read the market to book ratio which can prove to be of a great help in analyzing true value.