Market Value Ratio
Market value ratios are used to evaluate the share price of a company’s stock. It compares the company’s stock price to its earnings or assets. Market ratios show how investors feel about owning a company’s stock and how much it costs to issue that stock. They’re about how much shareholders earn from their investment and how it links to the value of the company’s shares.
This ratio helps understand if a stock is valued high or low in the market. High ratios may mean investors see potential, while low ratios could suggest a different view.
Abbreviations
(Note: These are not ratios, but values in currency.)
COGS = Cost of goods sold, or cost of sales.
EBIT = Earnings before interest and taxes
EBITDA = Earnings before interest, taxes, depreciation, and amortization
EPS = Earnings per share
Common market value ratios include the following:
Book value per share ratio = (Shareholder’s equity – Preferred equity) / Total common shares outstanding
The book value per share ratio calculates the per-share value of a company based on the equity available to shareholders.
Dividend yield ratio = Dividend per share / Share price
The dividend yield ratio measures the amount of dividends attributed to shareholders relative to the market value per share.
Earnings per share ratio = Net earnings / Total shares outstanding
The earnings per share ratio measures the amount of net income earned for each share outstanding.
Price-earnings ratio = Share price / Earnings per share
The price-earnings ratio compares a company’s share price to its earnings per share. It measures how many times the earnings per share (EPS) has been covered by current market price of an ordinary share. It is computed by dividing the current market price of an ordinary share by earnings per share.
Price-to-Book Ratio = Market Price per Share / Book Value per Share
Price-to-Book (P/B) Ratio: This ratio compares a company’s stock price to its book value per share. Book value represents the company’s net assets (assets minus liabilities) divided by the number of outstanding shares. A higher P/B ratio suggests that investors believe the company’s assets are worth more than their book value.
Price-to-Sales Ratio = Market Price per Share / Sales per Share
Price-to-Sales (P/S) Ratio: This ratio compares a company’s stock price to its sales per share. A higher P/S ratio indicates that investors are willing to pay more for each dollar of sales, suggesting that they have confidence in the company’s ability to generate revenue.
Enterprise Value Ratio = Enterprise Value / Sales
Enterprise Value (EV)/Sales Ratio: This ratio measures a company’s overall value relative to its sales, considering not only its equity value but also its debt and cash holdings. A higher EV/Sales ratio suggests that investors believe the company has strong growth potential.
Interpretation of Market Value Ratios
Market value ratios should be interpreted in context, considering factors such as industry benchmarks, the company’s growth prospects, and overall market conditions. A high ratio may indicate strong investor confidence, while a low ratio may suggest undervaluation or concerns about the company’s future performance.
Benefits of Market Value Ratios
Market value ratios provide valuable insights for:
- Investors: Assessing the relative valuation of potential investments and making informed investment decisions.
- Analysts: Evaluating a company’s financial health, performance, and growth prospects compared to its peers.
- Company management: Identifying areas for improvement, making strategic decisions, and communicating with investors.
Overall, market value ratios are essential tools for understanding a company’s valuation, relative performance, and financial health. By analyzing these ratios, investors, analysts, and company management can make informed decisions about investments, strategies, and financial planning.
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Other useful market ratios
Here’s an explanation of each ratio along with its formula:
1. EV/EBITDA
The EV/EBITDA ratio is a valuation metric that measures a company’s overall value relative to its earnings before interest, taxes, depreciation, and amortization (EBITDA). It is calculated by dividing the enterprise value by the company’s EBITDA.
Formula:
EV/EBITDA Ratio = Enterprise Value / EBITDA
Explanation:
The EV/EBITDA ratio is considered a more comprehensive measure of valuation than the P/E ratio because it excludes the effects of financing and capital structure. A higher EV/EBITDA ratio suggests that investors believe the company has strong profitability and cash flow generation potential.
Calculation:
Assume a company has an enterprise value of $10 billion and an EBITDA of $2 billion. The EV/EBITDA ratio would be:
EV/EBITDA Ratio = 10 billion / 2 billion = 5
2. EV/Sales
The EV/Sales ratio is another valuation metric that measures a company’s overall value relative to its annual sales. It is calculated by dividing the enterprise value by the company’s net sales.
Formula:
EV/Sales Ratio = Enterprise Value / Net Sales
Explanation:
The EV/Sales ratio is often used to compare companies within the same industry, as sales are a more standardized measure of performance across industries. A higher EV/Sales ratio suggests that investors believe the company has strong growth potential and is likely to generate more revenue in the future.
Calculation:
Assume a company has an enterprise value of $10 billion and annual sales of $2 billion. The EV/Sales ratio would be:
EV/Sales Ratio = 10 billion / 2 billion = 5
3. Cost/Income ratio
The cost/income ratio is a measure of a company’s operating efficiency. It is calculated by dividing the cost of goods sold (COGS) by the gross profit.
Formula:
Cost/Income Ratio = COGS / Gross Profit
Explanation:
A lower cost/income ratio indicates that a company is generating more profit from each dollar of sales. This suggests that the company is managing its costs effectively and is able to convert more of its revenue into profit.
Calculation:
Assume a company has a COGS of $80 million and a gross profit of $120 million. The cost/income ratio would be:
Cost/Income Ratio = 80 million / 120 million = 0.67
4. Sector-specific ratios
In addition to the general market ratios discussed above, there are also sector-specific ratios that are relevant to companies in particular industries. These ratios are designed to capture the unique financial characteristics of each industry.
For example, the debt-to-equity ratio is a common ratio for companies in the manufacturing industry, while the occupancy rate is a key metric for hotels and other real estate companies.
5. EV/capacity
The EV/capacity ratio is a valuation metric that is often used to evaluate companies in the oil and gas industry. It is calculated by dividing the enterprise value by the company’s proven oil and gas reserves.
Formula:
EV/Capacity Ratio = Enterprise Value / Proven Oil and Gas Reserves
Explanation:
The EV/capacity ratio is used to assess a company’s valuation relative to its resource base. A higher EV/capacity ratio suggests that investors believe the company has valuable reserves that can be developed into profitable production.
6. EV/output
The EV/output ratio is another valuation metric that is used to evaluate companies in the oil and gas industry. It is calculated by dividing the enterprise value by the company’s annual production of oil and gas.
Formula:
EV/Output Ratio = Enterprise Value / Annual Production
Explanation:
The EV/output ratio is used to assess a company’s valuation relative to its current production levels. A higher EV/output ratio suggests that investors believe the company has the potential to increase its production in the future.
These are just a few examples of the many different market ratios that are used by investors and analysts to evaluate companies. The specific ratios that are most relevant will depend on the industry, the company’s financial position, and the investor’s objectives.
Examples
1. The market price of an ordinary share of a company is $50. The earnings per share is $5. Compute price earnings ratio.
Solution:
=$50 / $5
= 10
The price earnings ratio of the company is 10. It means the earnings per share of the company is covered 10 times by the market price of its share. In other words, $1 of earnings has a market value of $10.
2. Hello Ltd. has a net income of $1 million in the third quarter. The company announces dividends of $250,000. Total shares outstanding is at 11,000,000.
The EPS of Hello Ltd. would be:
EPS = ($1,000,000 – $250,000) / 11,000,000
EPS = $0.068
Since every share receives an equal slice of the pie of net income, they would each receive $0.068.
4. EPS computation with cumulative preferred stock:
Following data has been extracted from the financial statements of Peter Electronics Limited. You are required to compute the earnings per share ratio of the company for the year 2020.
Net income for the year 2020: $1,500,000
6% cumulative preferred stock outstanding on December 31, 2020: $3,000,000
$15 par value common stock outstanding on December 31, 2020: $2,376,000
The number of shares of both types of stock are same as they were on January 01, 2020 because the company has not issued any new shares of common or preferred stock during the year 2020.
Solution:
From the above data, we can compute the earnings per share (EPS) ratio as follows:
= ($1,500,000 – $180,000*)/158,400
= $1,320,000/158,400
= 8.33 per share
The EPS ratio of Peter Electronics is 8.33 which means every share of company’s common stock has earned 8.33 dollars of net income during the year 2020.
* Dividend on preferred stock: $3000,000 × 0.06 = $180,000
5. EPS computation without preferred stock:
Hello Company had a net income of $600,000 for the year 2020. The weighted average number of shares of common stock outstanding for the year were 200,000. What was the earnings per share ratio of Hello Company?
Solution
Earnings per share = Net income/Weighted average number of shares outstanding
=$600,000/200,000
= $3.00 per share
Sources: PinterPandai, The Balance Small Business, Accounting Tools, Corporate Finance Institute
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