The book-to-market ratio is the book worth of equity apportioned by the market worth of equity. The emphasized book-to-market result is also named as value impact. In crude terms, great book-to-market shares also mentioned as value stocks, gain important positive excess revenues while low book-to-market stocks, also referred as growth shares, obtain meaningful negative excess returns. The effect of this ratio is adequately recorded in economics (N.Cakici, K.Topyan 2014, chap.9). The book-to-market ratio ventures to recognize undervalued or overvalued securities. The book-to-market proportion and the measurement of a company's investment are set determinants that have been affirmed to be beneficial in defining the cross-sectional difference in consequent returns (A.R. DeFusco, W.D. McLeavey, E.J. Pinto, E.D. Runkle, J.P.M. Anson 2015, p.449).
Formula of the Book-to-Market Ratio
The formula of the Book-to-Market Ratio is presented as (J.Y.Campbell., A.W.Lo., A.C.MacKinlay 2012, p.240):
Assumptions of the Book-to-Market Ratio
Assumptions of the Book-to-Market Ratio are presented qua (W.H.Beaver, M.Correia, M.McNichols 2011, p.54-55):
- If the accounting book amount of investment and market worth of equity are equal, the proportion would be 1, or there are unrecognized improvements in the financial value of material values or unrecognized intangible assets, in which case the ratio is below 1.
- The Book-to-Market ratio could take values from one if economic attenuation to asset amounts are unrecognized in which case the rate is over 1.
- If book to market ratios have the biggest departure from 1, the prophetic power of the bankruptcy models, both valuing and market-based is smaller.
An inverse of the Book-to-Market Ratio
The market-to-book ratio is inverse of the book-to-market ratio. Similar to the book-to-market ratio, it aims to estimate whether the company's stocks are exaggerated or undervalued by confronting the market price of all outstanding shares with the company's equity. The formula of the Market-to-book ratio is presented as (E.F.Bringham, M.C.Ehrhardt 2013,p.111):
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Author: Paulina Zając