Market capitalization, or market cap, is the market value of all of a company’s common stock. Stockholders’ equity, which is also known as book value, is the accounting value of the claim stockholders have on a company’s assets. A company reports stockholders’ equity on its balance sheet. The market cap is the price you could theoretically pay to own all of a company’s stockholders’ equity. You can compare a company’s market cap to its stockholders’ equity using the price-to-book ratio. This ratio helps you determine whether the market undervalues or overvalues a company’s stockholders’ equity.
Locate a company’s balance sheet in its most recent Form 10-Q quarterly report or 10-K annual report. You can download Forms 10-Q and 10-K from the investor relations page of its website or from the U.S. Securities and Exchange Commission’s online EDGAR database.Step 2
Find the company’s total stockholders’ equity, listed on the balance sheet.Step 3
Look up the company’s market capitalization on any financial website that provides stock quotes.Step 4
Divide the company’s market cap by its stockholders’ equity to calculate its price-to-book ratio. For example, if a company has $600 million in stockholders’ equity and an $800 million market cap, divide $800 million by $600 million to get a P/B ratio of 1.33.Step 5
Check if the P/B ratio is greater than 1. If it is, the market overvalues the company’s stockholders’ equity, which means investors believe its stockholders’ equity is worth more than its accounting value on the balance sheet. A high P/B ratio can occur for various reasons, such as investor optimism about the company’s future earnings. If you buy a stock with a high P/B ratio, you pay a premium over its book value. In this example, the P/B ratio is 1.33, which means the company’s stock is overvalued compared with its book value.Step 6
Check if the P/B ratio is less than 1. If it is, the market undervalues the company’s stockholders’ equity. Investors might expect the company to perform poorly or might be pessimistic about the company for various other reasons. When you buy a stock with a low P/B ratio, you get shares at a discount to book value.
- A company’s stock typically trades at a P/B ratio similar to those of its competitors. Compare a company’s P/B ratio with those of its competitors to determine how the market values its stock relative to its peers.
- If a company has preferred stock, subtract the value of its preferred stock from stockholders’ equity before comparing stockholders’ equity to its market cap.
- A stock’s P/B ratio does not guarantee it will perform in any particular way in the future.