Key Takeaways
- P/B ratio compares the market value of the company (their market capitalization) to its book value
- Price to Book value = Share price / Book value per share
- It is used for valuation of a company when its earnings are very low or in negatives
- Usually a price to book value which is under 1.0 is considered to be a fairly good value because this indicates undervaluation
What is Price to Book Value (P/B Ratio)?
P/B ratio compares the market value of the company (their market capitalization) to its book value which basically means that it is a comparison between the company’s stock price with its book value per share. They are particularly useful when a company has consistent low or negative earnings and PE ratio cannot be used. Price to book value ratios are able to provide meaningful insight to the analysts and investors.
P/B ratio shows the market’s perception of a company’s equity to the book value of its equity. The market value reflects the company’s potential future cash flows whereas the book value reflects the historic data of equity issued in the past which could have been impacted by profits or losses.
How do you calculate P/B Ratio?
To calculate P/B Ratio the formula used is as follows:
P/B Ratio = Share price / Book value per share
Where
P/B Ratio = Book value / outstanding shares
And
Book value = Assets – Liabilities
If a company liquidates all of its assets and uses them to pay off all of its debt. The remaining value of the company indicates the company’s book value.
To extract the information for the given formula, you would have to take a look at the company’s Balance Sheet which can be found easily on the company’s website or, if it’s listed, on the stock exchange website as well.
For example:
Let’s say that a company x has a book value of Rs. 100,000 with around 100 shares outstanding with a single share price of Rs. 20
In order to get Book value per share, we will divide them:
So, Book value = 100,000/100 = 10
And for price to book value, we will divide the share price with the book value:
P/B Ratio = 20/10 = 2
This example shows us that the market price is valued twice its book value.
Understanding P/B Ratio
Usually a P/B Ratio which is under 1.0 is considered to be a fairly good value because this indicates that a stock is potentially undervalued, therefore a potentially good investment. However, it is important to note that there is no ‘specific’ good or bad value because ratio analysis varies industry to industry so what can be deemed good for one industry is not necessarily good for the other. For example, P/B ratio is meaningful for businesses which are capital intensive and that have assets which are tangible in nature. For industries that relate to technology or with intangible assets, P/B Ratio is not very effective for evaluation.
It is also important to note that P/B ratio alone does not have very strong standing and is often used along with other profitability metrics such as return on equity (ROE) in order to understand the company’s valuation more accurately. ROE shows how much profit a company generates from its shareholders’ equity. Usually both P/B ratio and ROE are in sync where if the ROE is experiencing growth, it is expected that P/B Ratio should be too. Large discrepancies between the two are a cause of concern.
