Price to Book Ratio
An easy to use guide to fair value!
The price to book ratio (P/B) is one of a number of relative valuation tools that are used as quick and easy shortcuts to analyse and screen stocks.
'Relative' in this context means relative to the stock price or to stock market prices at this point in time.
I use the term absolute valuation to refer to procedures that calculate the fair value of stocks using company data such as the methodogy described by McNivan. The stock price is not used in the calculation.
The P/B ratio is calculated by dividing the current closing price of the stock by the latest reported book value per share. It is also known as the price-equity ratio.
The price to book ratio is calculated as ...
P/B ratio = Stock price/ Book value
In some countries the P/B ratio is known as the net asset value (NAV) of a company or net tangible assets (NTA).
The book value of a company represents what the shareholder owns of a company, after netting total liabilities from total assets. It includes both tangible assets and intangible assets (such as patents and goodwill).
It is measured by dividing shareholders equity by the number of shares outstanding, as of the year end balance date.
Benjamin Graham suggested that reasonably priced US stocks could be identified by multiplying the P/E ratio by the P/B ratio. If the resulting number was below 22.5 then the stock represented reasonable value.
Shareholders equity is the capital invested from shareholders and from retained profits (i.e., not distributed as dividends). It is measured by adding share capital, reserves, retained profits and minority interest. It is equivalent to book value.
The book value represents the total value of the company's assets that shareholders would theoretically receive if a company were liquidated.
And by being compared to the company's market price, the book value can indicate whether a stock is under- or over-priced.
A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that there could be a problem with the company.
As with most ratios, the average P/B ratio may vary from industry to industry. It also provides some idea as to whether you're paying too much for what would be left if the company went bankrupt immediately.
Other ratios that belong in this relative valuation set include price to earnings ratio (P/E) which is the most popular because most investors use it, price to cash flow (P/CF), price to sales (P/S) and price to dividends (P/D).
Return from Price to Book Ratio to Financial measures
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