What Market Value Ratios Can Tell You About a Company
Market value ratios help evaluate the economic status of publicly traded companies and can play a role in identifying stocks that may be overvalued, undervalued, or priced fairly.
Although a wide variety of market value ratios are available, the most popular include earnings per share, book value per share, and the price-earnings ratio. Others include the price/cash ratio, dividend yield ratio, market value per share, and the market/book ratio. Each of these measures is used in a different way, but when combined, they offer a financial portrait of publicly traded companies. In addition, market value ratios give management an idea of what a firm's investors think of its performance and future prospects.
Market value ratios are also used to analyze stock trends. For example, a company's low price-earnings ratio may indicate the stock is an undervalued bargain in a stable industry, but it also could indicate the company's earnings prospects are relatively uncertain, and the stock may be a risky bet.
You should always consider various factors, including a range of market value ratios, when making a decision about an investment. A stock with one great-looking measure could be an undiscovered gem, or it could be a dud that's underpriced for a reason.
Earnings Per Share
Earnings per share measure a company's net income per share of outstanding stock, indicating a company's profitability to investors. To calculate earnings per share, divide the company's net income by the number of outstanding shares (the stock currently held by all shareholders). For example, if a company has $10 million in net income and 4 million outstanding shares, the earnings per share would be $10 million divided by 4 million, which amounts to $2.50.
Book Value Per Share
The book value is a company's equity (not including preferred stock) divided by the shares outstanding in the market. For example, if a company's total assets equal $15 million and its total liabilities equal $5 million, the total equity would be $10 million. If the company has $2 million in preferred stock, deduct that to get $8 million, the amount available to common shareholders. If there are 1 million outstanding shares, the book value per share would be $8, or $8 million divided by 1 million.
Market Value Per Share
Market value per share is the market value of a company divided by the total number of outstanding shares. This quite simply is the going rate for a share of common stock. The market value of the company can be determined by multiplying the price of its common stock by the number of outstanding shares.
Market/Book (M/B) Ratio
With the market/book ratio, analysts can compare a company's market value to its book value. The ratio can be calculated by dividing the market value per share by the book value per share. For example, if a company has a book value per share of $8 and the stock currently is valued at $10 per share, the M/B ratio would be calculated by dividing $10 (stock price) by $8 (book value per share). This would give you a ratio of 1.25. In other words, the market value of a share of stock is 25% greater than its book value.
A ratio of less than 1 can mean a stock might be undervalued, while a ratio greater than 1 might mean it's overvalued.
Price-Earnings (P/E) Ratio
The price-earnings ratio is the current price of the stock divided by the earnings per share. Earnings generally are calculated by looking at the last four quarters of financial results. For example, if a stock is trading at $25 per share and its earnings per share are $2.50, the P/E ratio would be $25 divided by $2.50, which equals a ratio of 10-to-1. Analysts also talk about a forward P/E ratio, which is the estimated P/E ratio for the next four quarters.
The price/cash ratio compares the price of a company's stock to its cash flow. To calculate this ratio, simply divide the market value of a share by the amount of cash flow per share. Cash flow per share is the amount of cash a company has on hand after taking depreciation into account. For example, if the price of a company's stock is $20 per share and the company has cash flow of $10 per share, the price/cash ratio would be $20 divided by $10, which equals 2. Typically, a lower number here is better because that means greater cash flow.
Dividend Yield Ratio
Analysts arrive at the dividend yield ratio by dividing the total dividend payments paid per year by the market price of the stock. For example, if a company pays out dividends quarterly in the amounts of $2.25, $2.50, $2.50, and $2.75, the total dividend payments for the year would be $10. If the price of the stock is $100, you would divide $10 (dividend payments) by $100 (stock price). The answer is 0.10, or 10%. Knowing this ratio helps you understand the return on your investment.