The concept of market-to-book ratios can be defined by a study of two contrasting strategies applied to maximize profits. General Electric Corporation has pursued a conservative growth strategy by focusing on being the best in each industry where it competes. Tyco International has focused on an aggressive strategy through rapid, multiple acquisitions.
Market-to-book ratios reveal if a stock is overvalued or undervalued. If the ratio is greater than one, then the stock is overvalued. In contrast, if the ratio is less than one, then the stock is undervalued. The degree to the value of the stock can be seen in the magnitude of the ratio. By examining these ratios for each stock, along with the net profit margins, the success of each strategy can be measured.
Based upon the most recent quarterly report from each General Electric (GE)'s and Tyco International (TYCO)'s websites, including current stock prices, the following information was gathered for each company.
Table 1 shows the data collected and calculated to lead to the market-to-book ratio for each corporation using the most current quarterly earning reports.
Table 1: Information Required to Calculate Market-To-Book Ratios
Total Common Stock Shares Outstanding 10,586 2,019
Current Stock Price $34.07 $27.15
Market Capitalization $360,677.22 $54,815.85
Shareholder Equity $102,730 $34,186
Market-To-Book Ratio 3.51 1.60
To calculate market capitalization, the total common stock shares outstanding are multiplied by the current stock price. To calculate market-to-book ratio, divide each company's market capitalization by that company's shareholders' equity.
(10,586 X $34.07) $102,730 = 3.51
(2,019 X $27.15) $34,186 = 1.60
Based on these market-to-book ratios, TYCO's strategy has provided greater shareholder wealth creation. This is evident by the smaller market-to-book ratio. Both are greater than one, so each company's stock is overvalued. However, GE's is...