Investment Markets

P/B (Price to Book Value) Ratio or M/B (Market to Book Value) Ratio

What is P/B (Price to Book Value) Ratio?

A financial ratio that is used to compare the market value of a stock to its book value is called price to book value ratio or P/B ratio. Due to using market value, it is also called the Market to Book Value ratio(M/B).

The financial ratio is derived by dividing the current closing price of a share by the book value of a share in the latest quarter.

It’s calculated by dividing the company’s stock price per share by its book value per share (BVPS).

An asset’s book value is equal to its carrying value on the balance sheet, and companies calculate it netting the asset against its accumulated depreciation.

Book value is also the net asset value of a company calculated as total assets minus intangible assets (patents, goodwill) and liabilities.

For the initial outlay of an investment, book value may be net or gross of expenses, such as trading costs, sales taxes, and service charges. Some people may know this ratio by its less common name, price-equity ratio.

What does the P/B ratio indicate?

A stock is termed as undervalued if it has a lower P/B ratio. A low P/B ratio may also mean a company has some problems with its fundamentals.

However, the ratio varies by industry to industry as in the case of most other financial ratios.

P/B ratio also provides an idea of whether an investor is paying too much to buy a stock for what would be left with if the firm goes bankrupt the next second.

Advantage of P/B Ratio

  • The P/B ratio measures the market’s valuation of a company relative to its book value.
  • The market value of equity is typically higher than the book value of a company.
  • It provides an idea of whether an investor is paying too much to buy a stock.
  • P/B ratio is used by value investors to identify potential investments.
  • P/B ratios under 1 are typically considered solid investments.
  • The book value of equity provides a relatively stable and intuitive metric they can easily compare to the market price.
  • For marked to market firm assets, P/BV is more useful the P/E multiple
  • Book value is a cumulative amount that is usually positive even the P/E multiple is negative because of negative earnings. Ergo P/BV can be used when P/E can not

Disadvantage of P/B Ratio

  • P/B ratios may not be comparable, especially for companies from different countries.
  • Book value can become negative because of a long series of negative earnings, making the P/B ratio useless for relative valuation.
  • Book values are meaningless in companies such as Apple, Microsoft, Google, Facebook, GlaxoSmithKline, etc. where their intangible asset like intellectual capital, internally generated goodwill, brand awareness, etc. are much more valuable than the assets per their balance sheets but are not included therein.
  • Low price-book ratios persistently outperform stocks with high price-book ratios.
  • Differences in accounting methods, such as US GAAP and IFRS can lead to different asset values. That makes the comparison harder
  • Inflation and technological change can cause the book and market value of assets to differ significantly. so book value is not an accurate measure of the value of shareholders investments

Formula of Price to Book Value Ratio

P/B Ratio = market price per share/book value per share

Where

Book Value per Share = (Total Assets – Total Liabilities) / Number of shares outstanding

Or

BVPS = (Total Shareholder Equity – Preferred Equity) ÷ Total Outstanding Shares

Example of P/B Ratio

Let’s an example by assuming that the best measure of book value is Total Assets – Total Liabilities.

We’ll also assume that the stock of Company ABC Inc is trading at $6 per share and there are 100 shares outstanding.

Book value = 2,000 – 1,500 = 500 (note that this is the same as owners’ equity)

So book value per share = 500 / 100 = $5

Therefore,

P/B ratio = $6 / $5 = 1.2

A P/B ratio of less than 1.0 can indicate that a stock is undervalued, while a ratio of greater than 1.0 may indicate that a stock is overvalued.

Interpretation and Analysis of Price to Book Value Ratio

A low ratio (less than 1) could indicate that the stock is undervalued (i.e. a bad investment), and a higher ratio (greater than 1) could mean the stock is overvalued (i.e. it has performed well).

Many argue the opposite and due to the discrepancy of opinions, the use of other stock valuation methods either in addition to or instead of the Price to Book ratio could be beneficial for a company.

The lure of the markets is so strong that an increasing number of investors come flocking with their hard-earned money. The uncertainties, the ups, and downs haven’t dampened their spirits, and investors hope to strike it rich. The adage ‘buy low, sell high’ works well.

So it does the good advice ‘invest for the long-term’.  But certain technical parameters, ratios, and numbers are sure to give investors a more detailed picture of the company stock they are pumping their money into.

Instead of simply following the crowd, friends, or financial advisors, an analysis of numbers will place you in a better position. This approach that involves simple technical analysis and research ensures your money is not invested in the wrong places.

A well-researched investment could be time-consuming. But it assures the safety of your investment and brings in an element of predictability into the highly unpredictable volatile markets.

The price-to-book ratio (P/B ratio) offers a more tangible measure of a company’s value than earnings do and hence it is evaluated by most conservative investors. P/B ratio is used to compare a stock’s market value with its book value.

It is calculated by dividing the current closing price of the stock by the latest quarter’s book value. P/B is equal to share price divided by the book value per share.

Let us first begin with understanding what book value is. Wondered how much a company is really worth and what is its correlation to its stock price? Book value reflects a company’s worth. It can be defined as the company’s assets minus its liabilities.

If the company pulled its shutters, this number suggests how much would be left after all the outstanding obligations are settled and assets sold off. A company that is performing very well will always be worth more than its book value for its ability to generate earnings and growth.

In essence, book value is what would be left over for shareholders if a company closes its operations, pays off its creditors, collects from its debtors, and liquidates itself.

Now coming back to the P/B ratio, this is a good matrix to value stocks of companies with large tangible assets in their balance sheets. A lower P/B ratio can mean that the stock is undervalued or something is fundamentally wrong with the company.

This ratio gives you an idea if you’re paying too much for what would be left if the company declared bankruptcy.

P/B ratio is particularly useful for value investors, who are always on the hunt for low priced stocks that the market has neglected.

 

If P/B is less than one, it normally tells investors that either the market believes the asset value is overstated, or the company is faring very badly in terms of returns on its assets.

P/B ratio indicates the inherent value of a company. Many investors have successfully used this to discover dormant stocks, held them over the long term, and booked good profits.

Though it has its own flaws, it offers an extremely easy tool for identifying clearly under or overvalued companies.

 

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