- the book value and
- market value of the company.
Book value (shareholders' equity on the company's balance sheet) is calculated as total assets less total liabilities.
It reflects the historical operating and financing decisions made by the company.
Management can directly influence book value (e.g., by retaining net income).
However, management can only indirectly influence a company's market value.
Market value of a company is primarily determined by investors' expectations about the about, timing and uncertainty of the company's future cash flows
A company may increase its book value by retaining net income, but it will only have a positive effect on the company's market value if investors expect the company to invest its retained earnings in profitable growth opportunities.
If investors believe that the company has a significant number of cash flow generating investment opportunities coming through, the market value of the company's equity will exceed its book value.
Price to book ratio (market to book ratio)
A useful ratio to evaluate investor's expectations about a company is the price to book ratio.
If a company has a price to book ratio that is greater than industry average, it suggests that investors believe that the company has more significant future growth opportunities than its industry peers.
It may not be appropriate to compare price to book ratios of companies in different industries because the ratio also reflects investors' growth outlook for the industry itself.
Accounting Return on Equity
An important measure used by investors to evaluate the effectiveness of management in increasing the company's book value is accounting return on equity.