The market to book ratio is a valuation metric used to compare the price of a stock to its book value. It is also called the price to book (P/B) ratio.
You can calculate the market to book ratio by dividing a company's market cap by its book value.
The book value is calculated by subtracting a company's liabilities from its assets. It is the theoretical amount of money left if you sell all the assets and pay all the liabilities.
A high market to book ratio indicates that a stock is expensive, while a low ratio indicates that it is cheap.
So-called value stocks often have a low market to book ratio, which indicates that you can buy the stock for a low price relative to the value of its assets.
Formula: how to calculate the market to book ratio
The formula to calculate the market to book ratio is very simple. You divide a company's market capitalization by its book value.
Formula: Market to Book Ratio = Market Capitalization / Book Value
Market cap is calculated by multiplying the stock price by the number of shares outstanding.
The simplest way to calculate book value is by subtracting all liabilities from all assets. Book value = total assets - total liabilities.
You can find total assets and liabilities on the company's balance sheet. The book value may also be shown on the balance sheet under shareholders' equity.
However, some sources use slightly different formulas to calculate book value.
You can also calculate the market to book ratio by dividing the stock price by the book value per share.
Formula: Market to Book Ratio = Stock Price / Book Value Per Share
The inverse of the market to book ratio is the book to market ratio. You calculate it by dividing the book value by the market cap.
Example market to book ratio calculation
Let's calculate the market to book ratio for a real company.
At the end of 2019, Tesla stock (TSLA) was trading for $418 dollars per share, with a market cap of $74 billion.
By looking at their 2019 balance sheet, we can see that they had assets of $34.3 billion and liabilities of $26.2 billion. Their book value was $34.3 - $26.2 = $8.1 billion.
Dividing their market cap by the book value gives them a market to book ratio of $74 / $8.1 = 9.1.
In other words, you are paying $9.1 for each dollar of net assets.
Should you invest based on this ratio?
The market to book ratio, or P/B ratio, is one of the most commonly used ratios to determine if a company's stock is cheap or expensive.
For example, a ratio below 1 indicates that the stock is very cheap, while a high ratio (such as over 3) may suggest that it is expensive.
A market to book ratio of less than 1 implies that you can buy the company for a lower price than the value of its assets.
So, if you were to buy the company, liquidate it and sell its assets and pay its liabilities, you would make a positive return on your investment.
However, keep in mind that a low or high ratio should not be used in isolation to evaluate a stock. When companies are trading for less than their book value, then they are usually cheap for a reason.
In addition, companies with a high market to book ratio may be expensive for a reason. They could be expected to make a lot of profits in the future.
That being said, the market to book ratio is not a good way to value all sorts of businesses. Some types of companies don't need a lot of physical assets to make money.
For example, many information technology stocks have a high market to book ratio. But they can still be immensely profitable and seem cheap according to other metrics, such as the PE ratio.
So, don't make any investment decisions based solely on this ratio. Make sure to look at other financial metrics and also compare the market to book ratio to other companies in the same industry.