Business Finance Online

Market Value Ratios


Market Value Ratios relate an observable market value, the stock price, to book values obtained from the firm's financial statements.

Price-Earnings Ratio (P/E Ratio)

The Price-Earnings Ratio is calculated by dividing the current market price per share of the stock by earnings per share (EPS). (Earnings per share are calculated by dividing net income by the number of shares outstanding.)

The P/E Ratio indicates how much investors are willing to pay per dollar of current earnings. As such, high P/E Ratios are associated with growth stocks. (Investors who are willing to pay a high price for a dollar of current earnings obviously expect high earnings in the future.) In this manner, the P/E Ratio also indicates how expensive a particular stock is. This ratio is not meaningful, however, if the firm has very little or negative earnings.

where

Market-to-Book Ratio

The Market-to-Book Ratio relates the firm's market value per share to its book value per share. Since a firm's book value reflects historical cost accounting, this ratio indicates management's success in creating value for its stockholders. This ratio is used by "value-based investors" to help to identify undervalued stocks.

where

Example Problems
Use the information below to calculate the Price-Earnings Ratio
and Market-to-Book Ratio.
Net Income: $
Total Owners' Equity: $
Stock Price: $
Number of Shares Outstanding:
Price-Earnings Ratio:
Earnings per Share: $
Market-to-Book Ratio:
Book Value per Share: $
   

 

© 2002 - 2010 by Mark A. Lane, Ph.D.