6.5 Market Value Ratios
3 min read•june 18, 2024
Market value ratios are crucial tools for investors to assess a company's stock performance and valuation. These ratios, including , price-to-earnings (P/E), and price-to-book (P/B), provide insights into profitability, investor expectations, and potential undervaluation or overvaluation.
By comparing these ratios across companies and industries, investors can make informed decisions about stock purchases. Understanding market value ratios helps in evaluating a stock's attractiveness, growth potential, and overall , ultimately guiding investment strategies and portfolio management.
Market Value Ratios
Earnings per share calculation
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- EPS assesses a company's profitability by dividing net income available to common shareholders by the weighted average number of common shares outstanding
- Formula:
- Net income represents the company's total earnings after expenses and taxes
- Preferred dividends are subtracted as they have priority over common stock dividends (cumulative, non-cumulative)
- Weighted average number of common shares accounts for changes in outstanding shares during the period (stock splits, buybacks)
- Higher EPS indicates greater profitability per share, making the stock more attractive to investors (Apple, Microsoft)
- EPS is a key input for calculating the price/earnings ratio and valuing stocks
- Investors compare EPS growth over time and across companies within the same industry (technology, healthcare)
- EPS is used to determine the of a stock
Price/earnings ratio comparison
- compares a company's stock price to its , indicating how much investors are willing to pay for each dollar of earnings
- Formula:
- Market price per share is the current trading price of the stock on the exchange (NYSE, NASDAQ)
- Higher P/E ratios suggest investors expect higher future growth and are willing to pay a premium (, Netflix)
- Lower P/E ratios may indicate the stock is undervalued or investors have lower growth expectations (utilities, telecoms)
- P/E ratios are compared within the same industry to assess relative valuation (Coca-Cola vs PepsiCo)
- Investors use the P/E ratio to evaluate the attractiveness of a stock and make investment decisions (buy, sell, hold)
- P/E ratios can be affected by , economic conditions, and company-specific factors (earnings growth, risk)
- typically have higher P/E ratios compared to
Market price vs book value
- represents the amount of equity available to common shareholders on a per-share basis
- Formula:
- Total shareholders' equity is the difference between a company's assets and liabilities on the balance sheet
- Preferred equity is subtracted as it takes priority over common equity in the event of liquidation
- Comparing market price to BVPS helps determine if a stock is potentially undervalued or overvalued
- If market price < BVPS, the stock may be considered undervalued (bargain)
- If market price >> BVPS, the stock may be considered overvalued (expensive)
- Price-to-book (P/B) ratio quantifies the comparison of market price to book value
- Formula:
- < 1 indicates potential undervaluation (Berkshire Hathaway)
- P/B ratio >> 1 suggests potential overvaluation (Tesla)
- Investors use P/B ratio with other valuation metrics (P/E, EV/EBITDA) to make informed investment decisions
- P/B ratios vary across industries due to differences in asset intensity and growth prospects (banks vs tech companies)
Market Efficiency and Stock Valuation
- Market efficiency refers to how well stock prices reflect all available information
- Efficient markets theory suggests that stock prices quickly adjust to new information, making it difficult to consistently outperform the market
- methods aim to determine a stock's fair value based on various factors:
- Discounted cash flow (DCF) analysis
- Comparable company analysis
- Dividend discount model
- impacts stock valuation, as it affects the cash flows available to shareholders
Key Terms to Review (38)
Alibaba: Alibaba is a Chinese multinational conglomerate specializing in e-commerce, retail, internet, and technology. It is one of the world's largest retailers and e-commerce companies, known for its online marketplaces such as Alibaba.com, Taobao, and Tmall.
Amazon: Amazon is a multinational technology and e-commerce company founded by Jeff Bezos in 1994. It is one of the largest companies by market capitalization and a key player in various market sectors including cloud computing, digital streaming, and artificial intelligence.
Amazon (AMZN): Amazon (AMZN) is a multinational technology company focusing on e-commerce, cloud computing, digital streaming, and artificial intelligence. It is publicly traded on the NASDAQ stock exchange under the ticker symbol AMZN.
Book Value Per Share: Book value per share (BVPS) is a financial metric that represents the per-share value of a company's assets, after subtracting its total liabilities. It provides an estimate of the intrinsic value of a company's stock, based on the company's net asset value. BVPS is an important consideration within the context of 6.5 Market Value Ratios, as it helps investors assess a company's valuation relative to its underlying assets.
Book Value per Share (BVPS): Book Value per Share (BVPS) is a market value ratio that measures the per-share value of a company's assets minus its liabilities. It provides an estimate of the intrinsic value of a company's stock based on its net assets and is often used to assess a stock's valuation relative to its book value.
COVID-19: COVID-19 is a global pandemic caused by the novel coronavirus SARS-CoV-2, significantly impacting economic activities and financial markets. It has led to disruptions in supply chains, market volatility, and changes in consumer behavior, affecting corporate financial health and investment decisions.
CVS Pharmacy (CVS): CVS Pharmacy (CVS) is a leading American retail pharmacy chain providing prescription medications, health care products, and services. It operates over 9,900 stores across the United States.
Dividend Policy: Dividend policy refers to the strategy a company employs in deciding whether to distribute profits to shareholders in the form of dividends or to retain those earnings for reinvestment in the business. This policy directly impacts the relationship between shareholders and company management, as well as the market value ratios that investors use to evaluate a company's performance and prospects.
Dividend yield: Dividend yield measures the annual dividend income an investor receives from a stock relative to its current share price. It is expressed as a percentage and helps investors evaluate the income-generating potential of a stock investment.
Dividend Yield: Dividend Yield is a financial ratio that measures the annual dividend paid per share relative to the current market price of the share. It represents the return an investor receives from a company's dividend payments, expressed as a percentage of the stock's price.
Earnings per Share: Earnings per share (EPS) is a key financial metric that represents the portion of a company's profit allocated to each outstanding share of common stock. It is a widely used indicator of a company's profitability and is an important consideration for investors when evaluating the performance and potential of a company's stock.
Earnings per share (EPS): Earnings per share (EPS) is a financial metric that indicates the profitability of a company allocated to each outstanding share of common stock. It is calculated by dividing net income by the number of outstanding shares.
Earnings per share (EPS): Earnings per share (EPS) is a financial metric that indicates the portion of a company's profit allocated to each outstanding share of common stock. It is a key indicator of a company's profitability and is used by investors to assess financial performance.
Earnings Per Share (EPS): Earnings Per Share (EPS) is a key financial metric that measures the profitability of a company by dividing the company's net income by the number of outstanding shares. It is a widely used indicator of a company's profitability and is often used by investors to evaluate the performance of a company's stock.
EPS is an important term in the context of both the Income Statement (Topic 5.1) and Market Value Ratios (Topic 6.5). It provides insight into a company's financial health and its ability to generate profits for its shareholders.
EBITDA (earnings before interest, taxes, depreciation, and amortization): EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a measure of a company's overall financial performance. It is often used as an alternative to net income in evaluating profitability.
Fundamental Analysis: Fundamental analysis is the study of a company's or asset's intrinsic value by examining its financial health, management, competitive position, and economic conditions. It aims to determine the true worth of an investment and identify potential mispricing in the market.
Growth Stocks: Growth stocks are shares of companies that are expected to experience above-average growth in earnings and revenue compared to the overall market. These stocks are typically characterized by high price-to-earnings (P/E) ratios, as investors are willing to pay a premium for the potential of future growth and capital appreciation.
Intrinsic value: Intrinsic value is the perceived or calculated true worth of a stock, based on future earnings or dividends. It is often used by investors to determine if a stock is overvalued or undervalued compared to its market price.
Intrinsic Value: Intrinsic value refers to the inherent worth or true value of an asset, security, or investment, independent of its market price. It represents the fundamental or underlying value of an investment, calculated based on an analysis of its financial and operational characteristics.
Investopedia: Investopedia is an online resource providing financial education and information. It offers articles, tutorials, and tools to help users understand complex financial concepts and terms.
Market capitalization: Market capitalization, or market cap, is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current share price by the total number of outstanding shares.
Market Capitalization: Market capitalization, often shortened to 'market cap,' is the total value of a company's outstanding shares of stock. It is calculated by multiplying the current market price of a single share by the total number of shares outstanding. Market capitalization provides a measure of a company's size and is an important factor in various financial analyses and investment decisions.
Market Efficiency: Market efficiency is a concept that describes the degree to which asset prices fully reflect all available information. In an efficient market, prices adjust rapidly to new information, and it is not possible to consistently earn excess returns through active trading strategies.
Market Sentiment: Market sentiment refers to the overall attitude or mood of investors and market participants towards a particular asset, market, or the economy as a whole. It reflects the collective perceptions, emotions, and expectations that drive market behavior and price movements.
Market Watch: Market Watch involves monitoring and analyzing financial markets to track the performance of securities, indices, and economic indicators. It provides crucial information for making informed investment decisions.
NOPAT (net operating profit after taxes): Net Operating Profit After Taxes (NOPAT) is a measure of a company's profitability that excludes the impact of financial leverage and non-operating items. It represents the profit a company would have if it had no debt and only operating assets were considered.
P/B Ratio: The price-to-book (P/B) ratio is a financial ratio that compares a company's market value to its book value. It is calculated by dividing a company's stock price per share by its book value per share. The P/B ratio provides insight into how the market values a company's assets and is an important metric in the context of stock valuation.
P/E Ratio: The price-to-earnings (P/E) ratio is a fundamental market valuation metric that compares a company's current stock price to its earnings per share (EPS). It provides investors with an indication of how much they are paying for a company's earning power.
P/E TTM: P/E TTM (Price-to-Earnings Trailing Twelve Months) is a financial metric that measures the current share price relative to its per-share earnings over the last twelve months. It helps investors assess whether a stock is overvalued or undervalued based on past performance.
Price-to-Book Ratio: The price-to-book ratio (P/B ratio) is a financial ratio that compares a company's market value to its book value. It is calculated by dividing the company's stock price per share by its book value per share. This ratio is used to evaluate the valuation of a company's stock and is an important metric in both market value ratios and multiple approaches to stock valuation.
Price-to-Earnings Ratio: The price-to-earnings (P/E) ratio is a fundamental metric used to value a company's stock. It compares a company's current stock price to its earnings per share, providing insight into whether the stock is undervalued or overvalued relative to its profitability.
Price/earnings (P/E) ratio: The Price/Earnings (P/E) ratio is a valuation metric that compares a company's current share price to its earnings per share (EPS). It indicates how much investors are willing to pay for each dollar of earnings, serving as a gauge of market expectations and valuation levels.
Stock buyback: A stock buyback is when a company purchases its own shares from the open market. This reduces the number of outstanding shares and can increase the value of remaining shares.
Stock Valuation: Stock valuation is the process of determining the intrinsic or fair value of a company's stock. It is a fundamental analysis technique used to assess whether a stock is undervalued or overvalued in the market, providing insights for investment decisions within the context of market value ratios.
Technical Analysis: Technical analysis is the study of market action, primarily through the use of charts, for the purpose of forecasting future price trends. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and trading volume, in an effort to determine probable future prices.
Tellurian Inc. (TELL): Tellurian Inc. (TELL) is a publicly traded company involved in the production and export of liquefied natural gas (LNG). It is headquartered in Houston, Texas, and aims to deliver low-cost LNG globally.
Value Stocks: Value stocks are shares of companies that are trading at a lower price relative to their fundamental financial metrics, such as earnings, dividends, or book value. These stocks are considered undervalued by the market and have the potential for significant appreciation as the market recognizes their true worth.
Yahoo! Finance: Yahoo! Finance is a comprehensive financial news and data platform that provides up-to-date information on stock markets, economic indicators, and personal finance. It also offers tools for tracking investments and analyzing market trends.