|

What Is A GOOD Price To Book Ratio (P/B Ratio) And How To Interpret?

()

Price-to-Book Ratio (P/B) is a financial ratio used in ratio analysis to help identify potentially undervalued stocks. Generally, value investors use this to evaluate how undervalued, or overvalued is a stock at its current price. A higher number will indicate it be more expensive, and a lower number will indicate the stock is less expensive. Price-to-Book Ratio (P/B) is also known as, PB Ratio or, Market-to-Book Ratio.

Numbers to be considered in Price-to-Book Ratio are:

  • Market Price per Share
  • Total Shareholders’ Equity
  • Preferred Equity
  • Total Outstanding Shares
  • Book Value per Share (BVPS)

Price-to-Book Ratio is a financial indicator used as a part of fundamental analysis, a relatively good way to determine if the stock is undervalued, or selling at a premium.

How Is The Price-to-Book Ratio Calculated?

The formula for Price-to-Book Ratio can be calculated by dividing the Market Price per Share by the Book Value per Share.

Price-to-Book Ratio = Market Price per Share/ Book Value per Share

Where the Book Value per Share (BVPS) is calculated by the following formula:

Book Value Per Share = [(Total Shareholder Equity – Preferred Equity) ÷ Total Outstanding Shares]

The long equation for calculating the P/B ratio is as below:

P/B Ratio = Market Price per Share/ [(Total Shareholder Equity – Preferred Equity) ÷ Total Outstanding Shares]

You can generally get these numbers from the balance sheet found in the annual financial report provided by the company.

Interpreting Price-To-Book Ratio

The book value used in the calculation will not include the intangible assets of companies, thus P/B ratio of some companies seems to be higher than what it should be. Technology companies such as Microsoft, Tesla, and Google are a few examples.

On the other hand, the P/B ratio can be an indispensable tool to evaluate a capital-intensive business. These businesses have a high level of tangible assets. Financial sectors such as Banks are one such example.

What does a Low Price-To-Book Ratio of less than 1.0 mean?

  • A Low P/B ratio of less than 1.0 means the stock price is selling below the book value of the company.
  • A Low P/B ratio may mean an undervalued company, but this can also be the result of serious underlying problems within that company, thus thorough investigation should be performed.

What does a Price-To-Book Ratio of 1 to 3 mean?

  • A P/B ratio of 1 to 3 means the stock price is selling at around the book value of the company.
  • When the P/B ratio of a stock is calculated to be above 1.0, it is said to be selling at a premium. Most stocks have a P/B ratio of a range of 1 to 3.

What does a High Price-To-Book Ratio of more than 3.0 mean?

  • A high P/B ratio of more than 3.0 means the stock price is selling above the book value of the company.
  • A high P/B ratio may mean an overvalued company, a hyped-up company with no assets. But this can also be due to P/B Ratio’s limitation, it is unable to include factors such as, future earning prospects, or intangible assets in the calculation.
  • Many great companies can have a high P/B simply because the intangible assets of these companies are not included in the calculation.

Editor’s Recommendation: Good Debt vs Bad Debt

Tangible Assets vs Intangible Assets

Before getting to know what is a good P/B ratio, let’s understand what is the difference between tangible assets and intangible assets.

What are Tangible Assets?

Tangible assets are physical assets or properties owned by a company. These are the main type of assets that the companies used to manufacture their products or perform a service.

Examples of tangible assets are:

  • Equipment
  • Cars, Ships, Planes
  • Land or land ownership
  • Properties

What are Intangible Assets?

Intangible assets do not exist physically but are owned by the company. These assets allow the company to generate potential revenue, thus they have a monetary value.

Examples of intangible assets are:

  • Copyright
  • Branding
  • Technology

What Is A Good Price-To-Book Ratio?

A good price-to-book ratio varies between types of businesses. Generally, a value investor will consider a P/B ratio of less than 1.0 to be an indication of an undervalued stock. Most investors also consider the P/B ratio of less than 3 to be acceptable.

However, there can be exceptions to the standard of a “good P/B ratio”.

A P/B ratio of less than 3.0 can be a good P/B ratio for companies with a lot of intangible assets such as companies in the IT industry.

A P/B ratio of more than 1.5 can be a bad P/B ratio for companies with a lot of tangible assets such as companies in the financial industry.

Generally speaking, you will want a low P/B when compared with the other companies in the industry those which are of a similar sector.

Average Price to Book Ratio by Sector

RankingSectorPB Ratio
1Energy1.28
2Financials & Real Estate1.56
3Utilities2.19
4Materials3.14
5Communications4.03
6Health Care5.01
7Industrials5.42
8Consumer Staples6.16
9Consumer Discretionary10.94
10Information Technology (IT)11.01

Source: siblisresearch

A quick look at the data gives us some interesting insight into the P/B ratio performance of different sectors:

  • The sector with the lowest average price-to-book ratio is Energy.
  • The sector with the highest average price-to-book ratio is Information Technology (IT).

Example On Price to Book Ratio

Let’s use an example to understand the calculation of the Price-To-Book Ratio formula better.

Connie is a smart value investor who is looking to invest in ABC Company from the energy sector.

Connie knows the importance of fundamental analysis. By performing a simple ratio analysis of the company, she can evaluate to see if the company is currently overvalued, or undervalued.

Price-To-Book Ratio is just one of the many fundamental analysis numbers that Connie needs to calculate.

As a value investor, the P/B ratio can help to quickly assess if the company is currently undervalued and worth investing in.

The company has provided the following information on the website:

InformationPrice Per Share
Market Price per Share$80
Book Value per Share$100

What is the Price To Book Ratio of the Company?

Price-To-Book Ratio is calculated by using the formula given below:

Price-To-Book Ratio = Market Price per Share / Book Value per Share

Price-To-Book Ratio = $80 / $100

Price-To-Book Ratio = 0.80

The calculated price-to-book ratio of the company is 0.80. The calculated P/B Ratio is less than 1.0 which indicates that the stock may be undervalued.

This passes Connie’s 1st requirement as a value investor. Thus, she proceeds to perform other financial ratio analyses of the company.

Editor’s Recommendation: How Much Do You Need To Retire? Get Your Retirement Number with Our Retirement Calculator!

Benefits And Limitations Of the P/B Ratio

Benefits

  • Measures Price: The P/B Ratio provides a quick way to screen for undervalued stock.
  • Measures Risk: A low P/B ratio may not directly mean it is a lower-risk investment, but it means you are paying less for the stock. By understanding the average P/B ratio of the sector, the investor can have a rough idea of “how expensive”, or “how cheap” is the stock at its current price.

Tip: Use Price-To-Book Ratio to compare companies that are from a similar sector and size.

Limitations

  • Sector/ Industry Dependent: Price-To-Book Ratio’s main limitation is that it does not include intangible assets like technology, copyrights, and branding, which leads to a high P/B ratio. Thus, it is very industry specific.

My Takeaway

Price-to-Book Ratio is a great tool to screen for undervalued companies. P/B ratio is commonly used by most value investors and is usually used in conjunction with other financial ratios, such as; Quick Ratio, Debt to Equity Ratio, and Price to Earning Ratio (PE).

EPS growth rate, Return on Equity, and MOAT of a company are some other important criteria to consider when buying a stock.

“It’s far better to buy a wonderful company at a fair price, than a fair company at a wonderful price.”

Warren Buffett

Join 900+ BUDDIES who are growing their wealth with our weekly Income Newsletter




How useful was this post?

Click on a star to rate it!

Want more helpful content like this?

Follow us on social media!

We are sorry that this post was not useful for you!

Let us improve this post!

Tell us how we can improve this post?

Founder & Financial Writer at Income Buddies | Website | Posts by Author

Antony C. is a dividend investor with over 15+ years of investing experience. He’s also the book author of “Start Small, Dream Big“, certified PMP® holder and founder of IncomeBuddies.com (IB). At IB, he share his personal journey and expertise on growing passive income through dividend investing and building online business. Antony has been featured in global news outlet including Yahoo Finance, Nasdaq and Non Fiction Author Association (NFAA).

What are your thoughts?