Investor Facts: What Is Mark to Market?

Posted on November 26, 2018 at 7:17 AM PDT by

Mark to market is an accounting standard that requires a company to state the value of its assets in immediate, daily terms.

Most investors are used to thinking about their stocks or bonds in the mark-to-market sense. That’s because public investments are priced minute-to-minute throughout the day by millions of buyers and sellers.

The assets of a private corporation, however, are not as easily valued and often are open to significant interpretation.

mark to market

Part of the problem is that many of these assets have no natural buyers — say, plant equipment already in service.

But in the case of some companies, and particularly financial companies, the idea of mark-to-market accounting can become quite important.

For instance, a bank that holds a large number of mortgages might figure the collective value of those loans to be at a specific level based on recent home valuations in the same area.

Then a downturn in the housing market comes and borrowers start to default. Maybe a large percentage of those borrowers were unqualified in the first place.

In that case, the collectability of those debts is in question. If the housing market continues to decline, the resale value of the underlying properties also is in question.

An investor in that bank might want to know the mark-to-market value of the bank’s assets in order to decide whether to invest or stay away.

But in such quickly changing conditions it can be hard, even impossible, for the bank to say.

There have been changes to the accounting standards in recent years, particularly following the 2008 housing crash, to allow banks to peg the value of loans to the long-term historical value of the properties.

That way, they don’t have to accept valuation based on short-term reversals in the housing market, much lower prices that can happen in a liquidation process and feed a spiral of even lower valuations.

Book value and market value

In the case of stocks, there are two valuations: book value and market value.

Book value is the ongoing value of the firm itself based on current profit and loss. Usually this is sales minus costs and expenses. It’s what the company makes over time just by staying in business.

Market value is speculative since it’s based on a projection of future earnings. If earnings are going up the market value can be higher. If falling, then lower.

Marking a company to market closes the gap between market value and book value. It answers the question: If you had to sell the company today, what’s it worth in actual terms?

Investors often like to know the mark-to-market value of a company they own through the stock market. The idea is to understand how large (or small) a gap there might be in these two figures.

If future earnings growth warrants the difference in valuation, the investor might be disposed to hold more of the stock. Or, conversely, he or she might choose to sell the stock and buy some other investment.

MarketRiders, Inc. is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.




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