Book to market ratio

Book to market ratio
See also


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[edit]

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]\[{Book-to-Market}=\frac{ BE }{ ME }\]

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[edit]

  1. J. Pontiff & L. D. Schall 1998, 142
  2. S. P. Kothari & J. Shanken 1997, 170
  3. E. F. Fama & K. R. French 1995, 132
  4. E. F. Fama & K. R. French 1995, 131
  5. J. M. Griffin & M. L. Lemmon 2002, 2318
  6. J. Liew & M. Vassalou 2000, 222
  7. S. P. Kothari & J. Shanken 1997, 171
  8. E. F. Fama & K. R. French 1995, 132

References[edit]

Author: Krystian Prorok