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Book-to-Market Ratio Definition
The book-to-market ratio is a ratio used to determine the value of a company by comparing its book value to its market value. The market value of a company is derived from the value (price) of its stock in the market while the book value is the accounting value of the company as stated in the balance sheet. The book-to-market ratio is estimated by comparing both the market and book value of a firm.
A Little More on What is the Book to Market Ratio
The book-to-market of a company tells an investor whether a particular company is underpriced (undervalued) or overpriced (overvalued). A company is overvalued when its market value is higher than its book value and when the book value is higher than the market value, the company is undervalued. The book value of a company can be calculated from the company’s balance sheet while the market value of a company is determined through its market capitalization, that is, the outstanding shares of the company multiplied by the current share price in the market.
Reference for “Book-to-Market Ratio Definition”
Academic research on “Book-to-Market Ratio Definition”
Firm size, book‐to‐market ratio, and security returns: A holdout sample of financial firms, Barber, B. M., & Lyon, J. D. (1997). Firm size, book‐to‐market ratio, and security returns: A holdout sample of financial firms. The Journal of Finance, 52(2), 875-883. Fama and French (1992) document a significant relation between firm size, book‐to‐market ratios, and security returns for nonfinancial firms. Because of their initial interest in leverage as an explanatory variable for security returns, Fama and French exclude from their analysis financial firms, thus creating a natural holdout sample on which to test the robustness of their results. We document that the relation between firm size, book‐to‐market ratios, and security returns is similar for financial and nonfinancial firms. In addition, we present evidence that survivorship bias does not significantly affect the estimated size or book‐to‐market premiums in returns. Our results indicate data‐snooping and selection biases do not explain the size and book‐to‐market patterns in returns.
Ratio analysis and equity valuation: From research to practice, Nissim, D., & Penman, S. H. (2001). Ratio analysis and equity valuation: From research to practice. Review of accounting studies, 6(1), 109-154.Financial statement analysis has traditionally been seen as part of thefundamental analysis required for equity valuation. But the analysis has typicallybeen ad hoc. Drawing on recent research on accounting-based valuation, this paperoutlines a financial statement analysis for use in equity valuation. Standardprofitability analysis is incorporated, and extended, and is complemented with ananalysis of growth. An analysis of operating activities is distinguished from theanalysis of financing activities. The perspective is one of forecasting payoffs to equities. So financial statement analysis is presented as a matter of pro formaanalysis of the future, with forecasted ratios viewed as building blocks offorecasts of payoffs. The analysis of current financial statements is then seen asa matter of identifying current ratios as predictors of the future ratios thatdetermine equity payoffs. The financial statement analysis is hierarchical, withratios lower in the ordering identified as finer information about those higher up.To provide historical benchmarks for forecasting, typical values for ratios aredocumented for the period 1963–1999, along with their cross-sectionalvariation and correlation. And, again with a view to forecasting, the time seriesbehavior of many of the ratios is also described and their typical “long-run,steady-state” levels are documented.
Stock selection using data envelopment analysis, Chen, H. H. (2008). Stock selection using data envelopment analysis. Industrial Management & Data Systems, 108(9), 1255-1268. – The purpose of this study is to adopt data envelopment analysis (DEA) to construct portfolios, and compare their return rates with the market index to examine whether DEA portfolios created superior returns. In addition, this study investigated whether using the “size effect” as a stock selection strategy is appropriate in Taiwan.
Foreign ownership in the Taiwan stock market—an empirical analysis, Lin, C. H., & Shiu, C. Y. (2003). Foreign ownership in the Taiwan stock market—an empirical analysis. Journal of Multinational Financial Management, 13(1), 19-41. This paper investigates foreign ownership in the Taiwan stock market from 1996 to 2000. From the perspective of informational asymmetry, foreign investors appear to favor large firms and low book-to-market stocks. Analytical results show that foreign investors strongly prefer firms with high export ratios with which they are more familiar on account of their higher foreign sales. Foreign investors hold more shares of high beta stocks than of low beta stocks for small firms. However, this result does not hold for large firms, implying that large firms have lower investment barriers than small firms. Foreign investors, due to their different tax status, may also hold slightly more stocks with low dividend yield. However, evidence for this assertion is inconclusive, with only a weak effect displayed by the sample considered here.
Market reactions to tangible and intangible information, Daniel, K., & Titman, S. (2006). Market reactions to tangible and intangible information. The Journal of Finance, 61(4), 1605-1643. The book‐to‐market effect is often interpreted as evidence of high expected returns on stocks of “distressed” firms with poor past performance. We dispute this interpretation. We find that while a stock’s future return is unrelated to the firm’s past accounting‐based performance, it is strongly negatively related to the “intangible” return, the component of its past return that is orthogonal to the firm’s past performance. Indeed, the book‐to‐market ratio forecasts returns because it is a good proxy for the intangible return. Also, a composite equity issuance measure, which is related to intangible returns, independently forecasts returns.