Example of a book-to-market ratio
For the purpose of this example, let’s assume that company A has a common shareholder equity of $5 billion, and a market capitalisation of $1.5 billion. To calculate the book-to-market ratio for company A, we would divide $5 billion by $1.5 billion, which would give a figure of 3.33. Since this is above one, it might indicate that company A’s stock is currently undervalued.
On the other hand, let’s look at company B, which has a common shareholder equity of $7 billion, and a market capitalisation of $45 billion. If we did the same calculation, dividing the shareholder equity of $7 billion by the market capitalisation of $45 billion, we would get a book-to-market ratio of 0.15. This would indicate that this company’s stock is currently overvalued.