A Market-to-Book (MTB) ratio above 1 basically means that the company is creating value. This indicates that the value assigned by the market to the company exceeds the amount of capital invested by its shareholders and creditors.

Here are the detailed implications of this ratio:

1. Wealth creation versus investment

The MTB compares the market value (what the asset is worth in the eyes of investors) with its book value (what it has cost to build).

• If MTB > 1: The company has managed to transform one euro invested into more than one euro of value. For example, an MTB of 2.5 means that the market considers that the company has created 1.50 of additional value for each euro invested.
• Link with MVA: an MTB greater than 1 mechanically corresponds to a positive MVA (Market Value Added). The MVA is the absolute difference between market value and book value. It represents the wealth created beyond the simple recovery of invested capital.

2. Evidence of superior financial performance

The level of MTB is directly related to the intrinsic financial performance of the company. The MTB is greater than 1 if the following two conditions are met:

• ROCE > WACC: Return on capital employed (ROCE after tax) is higher than the weighted average cost of capital (WACC).
• Positive Economic Profit: The company generates a positive Economic Profit (or EVA). It is this ability to generate a return above the cost of capital that the market “rewards” with a premium above book value.

3. An indicator of stock market credibility

The MTB also measures the credibility of the company in the eyes of investors regarding its future ability to generate value.

• If the actual MTB is higher than the “theoretical no-growth MTB” (calculated by the after-tax ROCE ratio divided by the WACC), this positive gap is called the “credibility gap”. It shows that the market anticipates that the company will grow while maintaining its performance above the cost of capital.
• Conversely, a negative credibility gap can indicate that the market doubts the sustainability of the current performance or the relevance of future investments.

Note on the calculation

There are two ways to calculate this ratio:

• Price-to-Book Approach: Market Capitalization / Book Equity. This ratio can be skewed if equity is low or negative as a result of a highly leveraged structure or accumulated accounting losses. It is then unusable.
• Economic approach (recommended): Enterprise Value (EV) / Capital Employed (CE). This method is more robust for establishing the relationship between operational performance and value.