The market value ratios are important for investors, management, etc as these ratios are used to decide whether the valuation of the shares are overvalued, undervalued or at par with the market. These ratios are used for making investment decisions in stocks of companies.
In investment of stocks, there are various financial metrics which are used to properly evaluate the prices of the shares so that the investment doesn’t go in vain. One of the majorly used financial metrics are the market value ratios which measure and analyze the prices of the stocks and compare the market prices for the peer industries and against other facts and figures. These ratios check the financials of the public companies which are traded in the secondary market to understand their financial position, whether the stocks are rightly valued or not and at what price shares should be bought or sold. The decision of buying and selling shares is very important and if not done at the right price then the money invested can be wasted. So, market value ratios analysis is very crucial to share market investments as well as in other investments and for company management as well.
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What is Market Value Ratios?
The market value ratios are the financial metrics which are used to evaluate the stocks of publicly traded companies. These ratios are mainly used by investors to check whether the share’s prices are valued correctly in the market or they are trading at a higher price or lower. The overvaluation or undervaluation of shares helps investors decide whether they should go long or short on the shares they are going to invest in. If a share is overpriced, the price will fall for sure in the future and thus an investor should short the shares for a while and if the stock is underpriced then one should go long on it.
There are different market value ratios used by the share market investors and some of the most used ratios are mentioned below:
Price/Earnings or PE Ratio
This is the most used and important ratio under this category of ratios. It is used to check whether the shares are over or underpriced as compared to its earnings potential. It is measured as the price of the share in the current time against the earnings the company has reported for the financial period on per share basis. For a detailed understanding, we recommend our detailed post on P/E Ratio.
This ratio shows the earnings of the company earned in a particular time period against the number of the company’s shares which are outstanding. This ratio is used to understand whether investing in it is worth the money or not. Reach our exclusive post on Earnings Per Share.
This ratio is again one of the most important market value ratios to analyze and decide whether the price per share of the company is at its market price or not. This ratio shows the relation between the book value of the company (total equity excluding the preference shares of the shareholders) and the outstanding shares in the market.
This is the ratio which is obtained by dividing the total market value of the shares of the company by the number of the shares which are outstanding. This gives the per share price in the market.
Investors check both the price and dividend earnings from a share so, this ratio helps in measuring the amount of dividend distributed in a year against the number of shares outstanding. This gives an insight into the company’s earning and investors can decide whether they want to invest in the shares which pay a certain level of dividend against the current price of the share in the market.
Read our in-depth post here Dividend Yield
Market to Book Ratio
This is the ratio which shows the relation between the market value of a share to its book value and thus one can easily figure out the difference between the two to evaluate whether the prices are under or overvalued as per the equity standing in the books.
Detailed post at Market to Book Ratio
Calculation and Formulas of Different Market Value Ratios
The formula for each market value ratio is as follows:
- Price/Earnings or PE Ratio = Price per share / Earnings per share (EPS)
- Earnings per Share (EPS) = Net Profit (Earnings) / total number of shares outstanding in the market
- Book Value per Share = (Shareholder’s Equity – Preference stock) / Outstanding numbers of shares.
- Market Value per Share = Market Capitalization / Outstanding shares in the market.
- Dividend Yield = Total dividend paid in a year / Number of shares outstanding.
- Market to Book Ratio = Price of one share / Book value of one share.
Market Value Ratios Uses
The market value ratios uses are varied and some of the most important uses are as follows –
- It gives an insight to the investor about the price of the shares, financial and managerial efficiency of the company.
- It also helps in the analysis of the future prospect of the company.
- This is required to analyze the different trends in the stock market.
- It can be used to find out the undervalued shares which have high potential to earn money in the future.
Therefore, market value ratios are useful in every phase of investment in a publicly traded company’s shares. The different market value ratios provide different insight of the company and investors can decide about their investment and strategies using these ratios.1–3