The Definition of "Market Value Ratio"

A market-value ratio is a metric used to gauge a company's viability in terms of such variables as profitability and the market valuation of its stock. Market-value ratios are calculated based on the figures expressed in a company's financial statements for a given period. These ratios are used analytically by a company's management as well as by its current and prospective investors.

Function

• A market-value ratio is an indicator that expresses the value of a company's stock in terms of a specific item in its financial statements. Different ratios indicate a company's viability, or financial health, where asset values, revenue, income, and ability to pay bills are concerned. Some of the most useful and widely known of these ratios include the price-to-earnings ratio (called the "P" or "P/E" ratio), the book-to-market ratio and the debt-to-equity ratio.

Financial Statements

• Financial statements express a company's fiscal situation by breaking its value down into discrete numerical components. Financial statements indicate financial activity for a specific period up to a definite date. The most widely recognized of these is the balance sheet, which expresses a company's value in terms of its assets, liabilities and stockholder equity. The income statement provides a breakdown of a company's revenue during a given period as well as the sources from which it was derived. The cash-flow statement details cash flow into and out of a company's accounts during a given time. These three statements provide the fundamental figures used for calculating market-value ratios.

Price-to-Earnings Ratio

• The Price-to-Earnings (P/E) ratio indicates the value of a company's stock relative to its financial performance. It is calculated by dividing the per-share market price of a company's stock by the company's earnings per share (EPS) as expressed on the income statement. It is sometimes called a multiple because it indicates the amount of money that must be invested in order to derive one dollar of earnings. For this reason, lower ratios are preferred to higher ones.

Book-to-Market Ratio

• The Book-to-Market ratio compares a company's value as displayed on its balance sheet to its total value in the stock market (share price x number of shares in the market). It is calculated by dividing a company's balance sheet value by its market value. Since a ratio of one (1.00) indicates an accurate stock valuation among investors, ratios less than one suggest that a company's stock is priced too high. By contrast, ratios greater than one indicate that a company's stock is priced at a discount to its true value.

Debt-to-Equity Ratio

• The Debt-to-Equity ratio reflects how a company uses money generated from loans and the sale of shares in order to pay for its assets. It is calculated by dividing a company's liabilities by its stockholder equity as expressed on the balance sheet. A ratio greater than one indicates that a company uses more debt than equity to pay for expanding its enterprise. By contrast, a ratio of less than one indicates that a company is leveraging more money from its investors. In this respect, lower ratios are preferable to higher ratios, because growth dependent upon high amounts of debt increases the risk that a company will be unable to meet its obligations.