Market value ratios

Market value ratios
Primary topic
Related topics
Methods and techniques

The market value ratios indicate the current company's value and, for publicly traded companies, its share price. These set of ratios is used commonly by investors to evaluate the attractiveness of a firm from the investment standpoint[1]. The most well know ratios are as following:

1) Price / Earnings ratio (P/E) - shows the market price in relation to companies earnings. Simply saying how many of dollars investor has to pay per each dollar of firms earning.

\( \mbox{Price to Earnings ratio} = \dfrac{\mbox{Market share price}} {\mbox{Earning per Share}}\)

2) Earnings per Share - Represents what portion of profit the company has generated per each issued share. The ratio does not reflect any current market price, but it is used by investors to measure the profitability of the firm and derive the share price according to what they think the company is worth. \(\mbox{Earnings per share} = \dfrac{\mbox{Net Income}} {\mbox{Number of shares outstanding}}\)

3) Market-book ratio. The market-book ratio shows how a firm is regarded by investors in terms of it's stock’s market price to its book value [2].

\(\mbox{Market-book ratio} = \dfrac{\mbox{Market share price}} {\mbox{Book value per share}}\)

Implementation of market value ratios[edit]

In financial management, structured and scientific decisions based on analysis of financial statements whereas market value ratios play the critical part[3]. Applying value ratios investors attempts to calculate an accurate estimation of a company’s future earnings stream in order to link security value with a current price and decide whether to purchase or liquidate an asset. Usage of ratios, by comparison of the performance of various firms within the same industry help investors to identify companies most suitable for their investment goals and evaluate trends in the firm’s financial position over time.

On another hand, a firm's creditors are rarely concerned about the firm's capitalization, but rather care about the ability to cover a firm's debts and payout the debt on time[4]. In this case, market value ratios are hardly applicable and debt or liquidity ratios would be more helpful.

Footnotes[edit]

  1. (Ohlson, 1995)
  2. (Brigham and Ehrhardt, 2011)
  3. (Tugas, 2012)
  4. (Tugas, 2012)

References[edit]

Author: Mariia Gordiyenko