Week 4 Market Value Ratios

Note: The textbook does not tell us what price Amalgamated’s stock was selling for in 2016, so for the purpose of calculating this ratio let us assume that the average price during the year was $50.

Let's assume that Amalgamated’s EPS for 2016 is $6.95

When this is compared to the industry average P/E ratio, or, to the market average P/E ratio, it gives you a measure of how expensive a stock is how much you have to pay to get a claim to $1 of the firm's earnings.

This ratio is said to reflect investors' expectations about the company’s future growth; the P/E ratio will be high if expectations for growth are high, and low if expectations for growth are low.

Note: Again we assume that the average price for Amalgamated during the year was $50 and the number of common shares outstanding was 50,000.

When this is compared to the industry average, or, to the market average, it gives you another measure of how expensive a stock is how much you have to pay to get a claim to $1 of the firm's assets.

Another way of looking at it is to recognize that book value represents the price that the original investors paid for their claim on the firm’s assets. The stock’s market price represents how much investors are willing to pay today for that claim. If the M/B ratio is higher than 1.0, therefore, you can say that the value of the equity claim has gone up.

Yet a third way of looking at the M/B ratio is to recognize that the book value of a firm’s stock represents the net worth of only the assets listed on the firm’s balance sheet. However, the firm possesses other assets that may not be listed on the balance sheet, such as the value of employees, the firm’s reputation, value of customer lists, and so on. The market price of a firm’s stock incorporates investors’ opinions of all these intangibles as well as the assets on the balance sheet. Therefore, the M/B ratio gives you an indication of the value of a firm’s intangible “non-listed” assets.