Principles of Managerial Finance

CHAPTER 2 Financial Statements and Analysis 67

LG6

The formula for the market/book ratio is

Market/book (M/B) ratio

Substituting Bartlett Company’s end of 2003 common stock price of $32.25 and

its $23.00 book value per share of common stock (calculated above) into the M/B

ratio formula, we get

Market/book (M/B) ratio1.40

This M/B ratio means that investors are currently paying $1.40 for each $1.00 of

book value of Bartlett Company’s stock.

The stocks of firms that are expected to perform well—improve profits,

increase their market share, or launch successful products—typically sell at

higher M/B ratios than the stocks of firms with less attractive outlooks. Simply

stated, firms expected to earn high returns relative to their risk typically sell at

higher M/B multiples. Clearly, Bartlett’s future prospects are being viewed favor-

ably by investors, who are willing to pay more than its book value for the firm’s

shares. Like P/E ratios, M/B ratios are typically assessed cross-sectionally, to get a

feel for the firm’s risk and return compared to peer firms.

Review Question

2–15 How do the price/earnings (P/E) ratioand the market/book (M/B) ratio

provide a feel for the firm’s risk and return?

2.8 A Complete Ratio Analysis

Analysts frequently wish to take an overall look at the firm’s financial perfor-

mance and status. Here we consider two popular approaches to a complete ratio

analysis: (1) summarizing all ratios and (2) the DuPont system of analysis. The

summary analysis approach tends to view all aspectsof the firm’s financial activ-

ities to isolate key areas of responsibility. The DuPont system acts as a search

technique aimed at finding the key areasresponsible for the firm’s financial

condition.

Summarizing All Ratios

We can use Bartlett Company’s ratios to perform a complete ratio analysis using

both cross-sectional and time-series analysis approaches. The 2003 ratio values

calculated earlier and the ratio values calculated for 2001 and 2002 for Bartlett

Company, along with the industry average ratios for 2003, are summarized in

Table 2.8, which also shows the formula used to calculate each ratio. Using these

data, we can discuss the five key aspects of Bartlett’s performance—liquidity,

activity, debt, profitability, and market.

$32.25



$23.00

Market price per share of common stock



Book value per share of common stock