The theoretical Market-To-Book (MTB) calculation is based on the fundamental relationship between the profitability generated by the company’s assets and the cost of financing these assets, adjusted for growth.
Here are the formulas and steps to perform this calculation:

1. The General Formula (with growth)

The theoretical MTB is calculated by taking the formula for enterprise value based on cash flow (DCF) and dividing it by Capital Employed (CE). The derived formula is as follows:

$\mathrm{Theoretical} \mathrm{MTB} =\frac{{\mathrm{ROCE}}_{\mathrm{NET}}–\mathrm{g}}{\mathrm{WACC}–\mathrm{g}}$

• Net ROCE: Return On Capital Employed after tax=$\frac{\mathrm{EBIT}\times (1–\mathrm{T})}{\mathrm{CE}}$

• g: Perpetual growth rate of earnings and capital employed.
• WACC: Weighted Average Cost of Capital (the return demanded by investors).

Calculation logic: This formula comes from the fact that Free Cash Flow (FCF) is equal to the operating profit net of tax minus the investment required to finance growth (g times Capital Employed). By discounting this flow to infinity (Gordon-Shapiro rent) and dividing by the amount of capital, we obtain the ratio above.

Calculation logic: This formula comes from the fact that Free Cash Flow (FCF) is equal to the operating profit net of tax minus the investment required to finance growth (g times Capital Employed). By discounting this flow to infinity (Gordon-Shapiro rent) and dividing by the amount of capital, we obtain the ratio above.

2. The special case: zero growth (g = 0)

If we assume that the company has reached maturity and is no longer growing (it is just investing to maintain its industrial tool), the formula is considerably simplified. This is the “floor” valuation level for a successful company:

$\mathrm{MTB} \mathrm{Zero} \mathrm{Growth}=\frac{{\mathrm{ROCE}}_{\mathrm{NET}}}{\mathrm{WACC}}$

• If the ROCE is 15% and the WACC is 10%, the theoretical MTB without growth is 1.5.
• If the MTB observed in the market is higher than this figure (e.g. 2), the difference represents the value of the growth anticipated by investors.

3. Usage: Calculating implied growth

A practical application of this formula is to reverse it to determine what the market’s expectations are. By equalizing the theoretical MTB with the MTB actually observed on the stock market, we can extract the implied growth rate g:

$\mathrm{MTB} \mathrm{Observed}=\frac{{\mathrm{ROCE}}_{\mathrm{NET}}–\mathrm{g}}{\mathrm{WACC}–\mathrm{g}}$

We deduce the implied growth rate:

$\mathbf{Growth}\mathbf{ }\mathbf{\left(}\mathbf{g}\mathbf{\right)}\mathbf{ }\mathbf{implied}=\frac{\mathrm{MTB}\times \mathrm{WACC}\times {\mathrm{ROCE}}_{\mathrm{NET}}}{\mathrm{MTB}–1}$

This makes it possible to check whether the market is realistic, optimistic or pessimistic about the future of the company.

Conditions for value creation

These formulas mathematically confirm the principles of value creation:

• If ROCE > WACC, then the MTB > 1 (The company is worth more than its accounting capital).
• Growth (g) acts as an amplifier: if the ROCE is greater than the WACC, the growth increases the MTB. If the ROCE is lower than the WACC, growth reduces the MTB (it destroys value faster).