What Are Market Value Ratios and How Are They Used?
Entering the stock market, either by investing in individual stocks on your own or by contributing to index funds within your employer-sponsored 401K, can be overwhelming and frustrating. The stock market has its own vocabulary and language, and it can be difficult to understand all of the different nuances.
But by taking the time to learn the lingo and how the market works, you can ensure your money works harder for you.
What Are Market Value Ratios?
Market value ratios evaluate the economic status of your publicly-traded company in the wider marketplace — in other words, whether your company's stock is overvalued, undervalued or priced fairly.
Although there are a wide variety of market value ratios in use, the most popular include earnings per share, book value per share and the price-earnings ratio. Others include the price/cash ratio, dividend yield, market value per share and the market/book ratio.
Each of these measures is used in a different way, but combined, they offer a pretty accurate financial portrait of a publicly-traded company.
How Are Market Value Ratios Used?
Potential and current investors use market value ratios to see how a company's current share price stacks up to its various metrics. In addition, market value ratios give management an idea of what the firm's investors think of the firm's performance and future prospects.
They're also used to analyze stock trends, although some context is necessary. For example, a company's low price-earnings ratio may indicate the stock is an undervalued bargain in a stable industry, but it also could indicate the company's earnings prospects are relatively uncertain, and the stock may be a risky bet.
That's why you should consider various factors, including a range of market value ratios, when making a decision about an investment. A stock with one great-looking measure could be an undiscovered gem, or it could be a dud that's underpriced for a reason.
Common Market Value Ratios
Here is some additional information on the most common market value ratios in use:
- Earnings per share. This measure a company's net income per share of outstanding stock, indicating a company's profitability to investors.
- Book value per share. This measures shareholders' common equity in the company, divided by the shares outstanding.
- Price-earnings ratio. As discussed above, the price-earnings ratio is the current price of one share of stock divided by the company's earnings. Earnings generally are calculated by looking at the last four quarters of financial results, although analysts also may talk about a "forward price-earnings ratio," which is the estimated price-earnings ratio for the next four quarters.
- Price/cash ratio. This ratio compares the price of a company's stock to its cash flow. Lower may be better — it may indicate a company is undervalued and is generating plenty of cash — but investors should look at other metrics to confirm this.
The Bottom Line
If the rest of the company's ratios are good, then the market value ratios should reflect that and the stock price of the firm should be high. Market value ratios measure different ways of looking at the relative value of a company's stock.