Price-to-Book Ratio (P/B) is a financial ratio used in ratio analysis to help identify potential undervalue stocks. Generally, value investors uses this to evaluate how undervalued, or overvalued is a stock at it’s current price. A higher number will indicate to be more expensive, and a lower number will indicate the stock to be 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 relatively good way to determine if the stock is undervalue, or selling at a premium.
How is Price-to-Book ratio calculated?
The formula for Price-to-Book Ratio can be calculated by dividing the Market Price per Share to 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 of 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
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, P/B ratio can be an indispensable tool to evaluate capital-intensive business. These business have 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?
- Low P/B ratio of less than 1.0 means the stock price is selling at below the book value of the company.
- 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?
- 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 stock 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?
- High P/B ratio of more than 3.0 means the stock price is selling above the book value of the company.
- 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.
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tangible assets vs intangible assets
Before getting to know what is a good P/B ratio, let’s understand what is the difference between a tangible assets and a intangible assets.
What is a 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:
- Cars, Ships, Planes
- Land or land ownership
What is an Intangible Assets?
Intangible assets do not exist physically, but are owned by the company. These assets allows the company to generate a potential revenue, thus they have a monetary value.
Examples of intangible assets are:
What is a Good Price-To-Book Ratio?
A good price-to-book ratio vary between types of businesses. Generally, a value investor will consider P/B ratio of less than 1.0 to be an indication of an undervalued stock. Most investors also consider P/B ratio of less than 3 to be acceptable.
However there can be exceptions to the standard of a “good P/B ratio”.
P/B ratio of less than 3.0 can be a good P/B ratio for companies with a lot of intangible assets such companies in the IT industry.
P/B ratio of more than 1.5 can be a bad P/B ratio for companies with a lot of tangible assets such companies in the financial industry.
General speaking, you will want a low P/B when compared with the other companies in the industry of those which are of the similar sector.
Average Price to Book Ratio by Sector
|2||Financials & Real Estate||1.56|
|10||Information Technology (IT)||11.01|
A quick look at the data give us some interesting insight on the P/B ratio performance of different sectors:
- Sector with lowest average price-to-book ratio is Energy.
- Sector with 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 need to calculate.
As a value investor, P/B ratio can help to quickly assess if the company is currently undervalued and worth investing.
The company has provided the following information in the website:
|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 maybe undervalued.
This passes Connie’s 1st requirement as an value investor. Thus, she proceed to perform other financial ratio analysis of the company.
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Benefits and Limitations
- Measures Price: 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 on “how expensive”, or “how cheap” is the stock at it’s current price.
Tip: Use Price-To-Book Ratio to compare companies that are from the similar sector and size.
- Sector/ Industry Dependent: Price-To-Book Ratio’s main limitations is that it does not includes intangible assets like technology, copyrights and branding, which leads to high P/B ratio. Thus, it is very industry specific.
Price-to-Book Ratio is a great tool to screen for undervalued companies. P/B ratio is commonly used by most value investors and are usually used in conjunction with the 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
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