Write in Essay Form Price-to-Book ratio is the ratio of market price per share a
ID: 1171733 • Letter: W
Question
Write in Essay Form Price-to-Book ratio is the ratio of market price per share and total equity (aka Book Value) per share. It is a measure of how much premium market assigns to the equity in the balance sheet. For Facebook (FB) this ratio is 7.04 (as of writing this assignment), 604% premium over book value. For Twitter (TwTR) this ratio is 2.81. That means, market is assigning about 181% premium over book value. Controversial Claim Since market is assigning a much-much higher premium over book value for FB, as a long-term investor interested in obtaining value, we should BUY TWTR and SHORT (SELL) FB. Feel free to use the published financial statements of both companies, as well as calculate any other financial ratios you deem appropriate for your argument. You can find said financial statements, among other places on finance.google.com, as well as finance.yahoo.com. Objective Students are expected to argue in favor of positions they may not necessarily agree with, and in the process, learn to understand where opposing views come from. Such skills are necessary to stay away from "incestuous amplification" that arises from groups of people who think alike. You are required to refute the statement made as li If it was made in a court of law in front of a judge. (Write in essay form)Explanation / Answer
As mentioned in the question the price to book ratio helps us to determine whether the stock of a company is overvalued or is undervalued. This is done by comparing the price of all outstanding shares with the net assets of the company. Market value of a company equals the current price of all outstanding shares while book value equal the net asset of the company (as determined by balance sheet) and the comparison involves the quantum of difference between market value and book value.
The price-to-book ratio of both Facebook and Twitter is above 1 and this means that investors are willing to pay more for both these companies than what their assets are actually worth for. The price-to-book ratio of Facebook is 7.04 and that of Twitter is 2.81. This means that while both Facebook and Twitter are overvalued, Facebook is more overvalued. But there might be a good reason for the existing premium. As such the price of shares of Facebook are more likely to drop in the future than Twitter. Another scenario that can happen is that prices of both stocks will drop in future but the quantum of drop in case of Facebook shares will be higher when compared to shares of Twitter.
Thus it does not make sense to buy the Twitter stock. The Facebook stock should be sold as it is commanding a very high premium but the Twitter stock can be held onto with the expectations that the premium will increase in the future. When premium further increases one can sell the Twitter stock as well.
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