Calculate and Interpret the Price-to-Book Ratio
The price-to-book ratio (P/B), also known as the “price-equity ratio”, is used to compare the book value of a company to its current market value. The measure can help gauge the relative value of a stock. A stock that is trading at a low price-to-book may be seen as undervalued, especially when its P/B is lower than its industry competitors. A low P/B could, however, indicate a dismal outlook for the company. For that reason, use of the P/B is typically a single data point in the fundamental analysis process.
What is Book Value?
Book value is an accounting term to denote the sum of company assets that shareholders would receive, in theory, if the company were to be liquidated. In other words, a company’s book value would be the company’s liabilities subtracted from the total of its tangible assets. A viable and growing company is always worth more than its book value since it is demonstrating the ability to grow and generate earnings.
Calculate the Price-to-Book Ratio
The formula for the price-to-book ratio can be written as:
P/B Ratio = Share Price / Book Value per Share
Like the Price/Earnings Ratio (P/E), a low P/B represents better value. In fact, value investors often use a low P/B in screening for value stock candidates. A P/B ratio less than 3.0 will often create interest for value investors.
A higher P/B ratio would imply that investors expect the company to derive more value for shareholders from its assets. It could also provide an indication that the stock is currently overvalued.
P/B ratios do not provide any insight regarding the company’s ability create earnings for its shareholders.
The Price-to-Book Ratio Varies by Industry
Like most ratios, the P/B will vary by the company’s industry. Those industries that are more capital-intensive will typically show lower P/B ratios that those industries that require less infrastructure.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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