Book to market ratio
Book-to-market ratio appears as a tool to making prediction about company's value by comparing common value of shareholder equity to the size of market cap. Ability to predict the future provided by use of book-to-market ratio can be used to making relevant decision and show whole estimation about real value of company's shares at a given point in time[1].
The meaning of Book-to-market-ratio
Many of economists or other people making actions in the area of finance over the years looked for a tool or method to predict financial future of a company. Bunch of experts conduct a researches to find a relevant variable, which may become proper base to predict a stock return by analize past actions of company's historical cost or estimating account value[2]. In 1992 in literature there was defined a two different variables by Fama and French, which can be described as market equity (ME) and book equity (BE). What is more, a few years later following studies allow to detect fact, that these variables are also sensitive to a size of analyzing company[3].
Book-to-market ratio, based on previous studies, can be framed in following formula[4]:
In the cited formula, book-to-market ratio is a result of comparing book equity (BE) to market equity (ME). When book-to-market ratio is low, what can be expected when book equity is much lower than market equity, it means that market value of the share is overvalued[5]. Similarly when it turns out that book equity is much higher than market equity, shares are undervalued. Whole use of tool refers to real value of share at a given point in time. Using a ratio to change the price results in correcting underpriced or overpriced value and allows to implement real price to the market[6][7]. However, BE/ME is only a tool refers to checking expected returns, which can fill the economic void but unfortunately, it cannot show complete economical situation and this is only a part of complicated analysis. Despite this fact, it is worthy to use for share price establishment and future actions[8].
Footnotes
- ↑ J. Pontiff & L. D. Schall 1998, 142
- ↑ S. P. Kothari & J. Shanken 1997, 170
- ↑ E. F. Fama & K. R. French 1995, 132
- ↑ E. F. Fama & K. R. French 1995, 131
- ↑ J. M. Griffin & M. L. Lemmon 2002, 2318
- ↑ J. Liew & M. Vassalou 2000, 222
- ↑ S. P. Kothari & J. Shanken 1997, 171
- ↑ E. F. Fama & K. R. French 1995, 132
| Book to market ratio — recommended articles |
| Equity Risk Premium — Net asset value per share — Look-Ahead Bias — Book value per share — Taylor rule — Book-to-Market Ratio — Book profit — Annual Basis — Calmar Ratio |
References
- Fama, E. F., & French, K. R. (1995). Size and book‐to‐market factors in earnings and returns. . "The journal of finance", 50(1), 131-155.
- Griffin, J. M., & Lemmon, M. L. (2002). Book‐to‐market equity, distress risk, and stock returns. . "The Journal of Finance", 57(5), 2317-2336.
- Kothari, S. P., & Shanken, J. (1997). Book-to-market, dividend yield, and expected market returns: A time-series analysis. . "Journal of Financial Economics", 44(2), 169-203.
- Liew, J., & Vassalou, M. (2000). Can book-to-market, size and momentum be risk factors that predict economic growth? . "Journal of Financial Economics", 57(2), 221-245.
- Pontiff, J., & Schall, L. D. (1998). Book-to-market ratios as predictors of market returns. . "Journal of Financial Economics", 49(2), 141-160.
Author: Krystian Prorok
