CP

The calculation for cash flow per share was shown in Chapter 9, but just to refresh

your memory, cash flow per share is calculated as net income plus depreciation and

amortization divided by common shares outstanding.

MicroDrive’s price/cash flow ratio is also below the industry average, once again

suggesting that its growth prospects are below average, its risk is above average, or

both.

Note that some analysts look at multiples beyond just the price/earnings and the

price/cash flow ratios. For example, depending on the industry, some may look at mea-

sures such as price/sales, price/customers, or price/EBITDA per share. Ultimately,

though, value depends on free cash flows, so if these “exotic” ratios do not forecast fu-

ture free cash flow, they may turn out to be misleading. This was true in the case of the

dot-com retailers before they crashed and burned in 2000, costing investors many bil-

lions.

Market/Book Ratio

The ratio of a stock’s market price to its book value gives another indication of how in-

vestors regard the company. Companies with relatively high rates of return on equity

generally sell at higher multiples of book value than those with low returns. First, we

find MicroDrive’s book value per share:

Now we divide the market price by the book value to get a market/book (M/B) ratio

of 1.3 times:

Investors are willing to pay relatively little for a dollar of MicroDrive’s book value.

The average company in the S&P 500 had a market/book ratio of about 5.62

in late 2001. Since M/B ratios typically exceed 1.0, this means that investors are

willing to pay more for stocks than their accounting book values. The book value

is a record of the past, showing the cumulative amount that stockholders have in-

vested, either directly by purchasing newly issued shares or indirectly through re-

taining earnings. In contrast, the market price is forward-looking, incorporating in-

vestors’ expectations of future cash flows. For example, in late 2001 American

Airlines had a market/book ratio of only 0.45, reflecting the crisis in the airlines in-

dustry caused by the terrorist attacks earlier in the year, whereas Dell Computer’s

market/book ratio was over 13, indicating that investors expect Dell’s past successes

to continue.

Table 10-1 summarizes MicroDrive’s financial ratios. As the table indicates, the

company has many problems.

Industry average
1.7 times.

$23.00

$17.92

1.3 times.

Market/book ratio
M/B

Market price per share

Book value per share

$896

50

$17.92.

Book value per share

Common equity

Shares outstanding

Market Value Ratios 387

See Ch 10 Tool Kit.xls
for details.

Analysis of Financial Statements 383