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.
While making investment in stocks, there are various financial metrics which are used to properly evaluate the prices of the shares or the market value of the shares so that the investment does not become a loosing proposition. 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 with 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 turn into losses. So, market value ratios calculation and interpretation is very crucial; for share market investments as well as in other investments; and for the company management as well.
Table of Contents
- 1 What is Market Value Ratios?
- 2 Calculation and Formulas of Different Market Value Ratios
- 3 Market Value Ratios Uses
- 4 Conclusion
What is Market Value Ratios?
The market value ratios are the financial metrics which are used to evaluate the stocks’ worth of publicly traded companies. These ratios are mainly used by investors to check whether the prevailing market share prices are in sync with the company’s performance. And thus valued correctly in the market or they are trading at a higher price or lower. The overvaluation or undervaluation of share 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 to 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 you to go through our detailed post on P/E Ratio.
This ratio shows the earnings of the company earned in the period under analysis period with respect to the outstanding number of the company’s shares during that period. This ratio is used to understand whether investing in it is worth the money or not. For further details about this ratio please reach our exclusive post on Earnings Per Share.
As we all know cash is a very important part of the business operations, sustenance and growth. Cash earnings per share is of recent evolution and gives a glimpse of the actual cash earned by the company per share. This is a further variation to the EPS. The formula to calculate the CEPS is somewhat like EPS with a small difference that all the non-cash items in the profit and loss statement is also added.
The exact formula is :
CEPS = (Net Earnings of the Company+ All non-cash expense items (depreciation, amortization, etc) – Tax Provision)/ outstanding number of equity shares. This is a very simple and easy formula therefore this formula is popular with the common investors.
There is one more formula to calculate CEPS. Analysts and big investors prefers to use this one. The result of both the formula at times vary slightly. The alternate formula is :
CEPS = Operating Cash Flow / Outstanding Number of Shares
This metric is of quite important and critical in case of start ups, capital intensive industries, where the expansion or diversification plan is under way or has just completed and full capacity utilization may take some time.
This ratio is again one of the most important market value ratios to analyze and decide whether the market price per share of the company is how near or far with respect to its book value per share. 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. Book Value is the intrinsic value in terms of fundamental analysis. And it is a total of the contributed value plus the operational profits or losses of the company over the years.
The formula is :
Book Value Per Share= (Equity Share Capital of the Company + All reserves and Surplus (part of shareholders kitty))/ the number of outstanding equity shares of the company.
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.
In other words, it is, total market capitalization of the company in the secondary market / total number of outstanding shares of the company.
Thus, Market Value or the trading price could suggest the total market capitalization of the company or vice versa.
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
- Cash Earnings per Share (CEPS) = Net Profit + Non-cash items / outstanding shares 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 usage of market value ratios is 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.
Market value ratios are very critical and useful for all sorts of stock investing. And be it secondary market investments, be it investment in a company as a minor or major stakeholder, or be it for merger and acquisition decision, etc. 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