This is a thorough guide on how to calculate Price to Book Value Ratio (P/B) with detailed interpretation, analysis, and example. You will learn how to use this ratio formula to perform a stock valuation.
Definition - What is Price to Book Value Ratio?
The price to book (P/B) value ratio is an important measure that is used to value a company’s stock. It compares the market value of a company to the book value of each of its shares.
There is no ‘ideal’ ratio but as a general rule for an investor, the lower the better as it implies the stock is undervalued and is therefore considered to be a better investment however caution should be taken as it could also mean that there is something fundamentally wrong with the company.
The value of the ratio also varies greatly across industries and so a good way to decipher just how positive the result is would be to compare the ratio to other similar companies.
If your goal as an investor is to find undervalued companies then this ratio offers a way to unearth high growth companies selling at lower prices.
In this case, a value that would be a cause for investment consideration would be below 3.0.
The formula to measure the Price to Book value is as follows:
Price to Book (P/B) = Stock Price Per Share / Book Value Per Share
Book Value Per Share = (Total Assets - Total Liabilities) / Number Of Outstanding Shares
You can find this information on a company’s financial statements.
NAW Company has the following information on its financial statements:
- Total Assets: $1,200,000
- Total Liabilities: $900,000
- Number of Outstanding Shares: 50,000
- Stock Price Per Share: 18.75
NAW Company’s P/B ratio is 3.13 which is slightly above the guideline of 3.0 for an investment consideration.
Interpretation & Analysis
If your goal as an investor is to find undervalued companies than NAW Company would probably not be a good option if you were being strict with the 3.0 guideline.
However, as it is so close to the guideline, as an investor, you would probably want to assess the company using other ratios before dismissing it completely as it could still be a good investment.
Without context, the ratio is difficult to evaluate and so we would need to look at other companies within the same industry in order to understand it further.
For example, if similar companies had much higher ratios then it could be a sign that NAW is either undervalued or alternatively, has something fundamentally wrong with it that you would need to find out with further analysis.
Cautions & Further Explanation
Companies can account for their assets in different ways meaning that the stated book value of a business might not be a real representation of the assets of a business.
One company might be aggressively depreciating their assets in comparison to another heavily distorting the results.
What can be considered a good ratio and how this is perceived also varies widely.
One analyst might argue that a low ratio means the stock is undervalued and therefore a good investment whereas another might view the low ratio as being a worse investment.