Names like Warren Buffett and Benjamin Graham might come to mind when you think of the greatest investors in the history of the stock market. These legendary investors are proponents of an investment plan known as value investing. No fundamental analysis metric has a stronger link to a company's value than the price-to-book ratio.
Key Takeaways
- One of the metrics that value investors use to test a company's value is the price-to-book or P/B ratio.
- The price-to-book value ratio looks at the value that the market places on the stock at a given point in time, as shown by its stock price, relative to the company's book value.
- You can figure out the price-to-book value ratio with the following formula: price-to-book ratio = stock price / (assets - liabilities).
- You'll find lower P/B ratios on stocks that could be undervalued. The more likely it is that the market has overvalued the stock if the P/B ratio is higher.
Value Investing and Book Value
Value investors don't concern themselves with earnings growth nearly as much as their perception of the intrinsic value of a company. They hope to find the value before the rest of the market.
One of the metrics that value investors use to test this value is the price-to-book or P/B Ratio. This metric looks at the value the market places on the stock at a given point in time relative to the company's book value. Market value is shown by its stock price.
Book value equates to the amount of shareholders' equity shown on a company's balance sheet. You can also figure a company's book value like this:
Assets - Liabilities = Book Value
Suppose a company stopped doing business without warning. Whatever assets that remain after you liquidate to pay off its debt equate to the firm's value. You can then divide that amount by the number of shares outstanding to arrive at the company's book value.
Note
Financially sound companies will always trade for more than their book value. Investors price the stock based in part on their anticipation of the firm's future growth.
Calculating the Ratio
You can calculate the price-to-book value ratio with this formula:
Price-to-book ratio = Stock price / (Assets - Liabilities)
Interpreting Your Result
You'll find lower P/B ratios on stocks that could be undervalued. The higher the P/B ratio, the more likely it is that the market has overvalued the stock. Think about the results within the context of other stocks in the same sector when you use this ratio to analyze a stock. Baseline price-to-book ratios will vary by industry group.
As with all fundamental analyses, many other factors leave this ratio open to interpretation. It can skew the price-to-book ratio if the price of a stock has been affected in the short term by market mechanics. This can make the ratio irrelevant.
It can also skew the meaning ofyour result if a company seems to have a large total assets number but it consists mainly of slow-moving inventory. You can use an average stock price based on the last 12 months when calculatingthe P/B ratio to filter out some of the noise.
Warren Buffett has often offered the wisdom of, "Price is what you pay. Value is what you get." You become less concerned about price when you're using the P/B ratio as an investor, although it has to factor in somewhat. You become more focused on the long-term value that you think lies within a company.
Only think about using the P/B ratio in your analysis if you have the patience to stay with a given stock for a long time. You'll find that using it to try to discover a short-term upside won't be an effective way to use it.
Note
Warren Buffett himself almost never sells his stocks, many of which he has held for decades. He patiently waits for them to achieve the value he thinks they possess.
Pros and Cons of Using the P/B Ratio
The P/B ratio helps investors gauge companies by providing a fairly stable metric that makes sense. Investors can easily compare it to a company's market price. The P/B ratio is still useful when a firm has a period with negative earnings, unlike price-to-earnings ratios.
It's somewhat less common to find a company with a negative book value versus one with negative earnings. But it will render the ratio useless in terms of estimating a company's value if a company has many periods of negative earnings,
The P/B ratio becomes less useful when firms classify balance sheet items differently due to the application of various accounting standards. This makes it much harder and less meaningful to compare P/B ratios across firms. This is especially problematic with a P/B ratio on a non-U.S. company.
Firms with few tangible balance sheet assets, such as service providers or tech firms, also make a comparison of P/Bs across companies meaningless if you're judging it by a company that holds a lot of inventory or equipment.
Look into earnings per Share (EPS), dividend payout ratio, price-to-earnings Ratio (P/E), dividend yield, price-to-sales (P/S), and return on equity for more on fundamental analysis.
FAQs
The P/ B Ratio represents the relationship between the market's perception of a company's value (reflected in its stock price) and the company's book value (the net asset value of the company's assets minus liabilities). It's a fundamental tool for value investors seeking stocks trading below their intrinsic value.
How do you analyze price-to-book ratio? ›
You can calculate the price-to-book, or P/B, ratio by dividing a company's stock price by its book value per share, which is defined as its total assets minus any liabilities. This can be useful when you're conducting a thorough analysis of a stock.
Why is a low PB ratio good? ›
Well, a higher P/B ratio, as discussed above, could indicate that the stock is overvalued, or that there is an expectation that it will perform well in the near future. Conversely, a lower P/B ratio might suggest the stock is undervalued or that investors expect the company to generate less value than its peers.
What is a good price per book? ›
A price-to-book less than 1 ratio could mean the stock is undervalued and worth buying. A price-to-book ratio greater than 1 indicates that the stock price is trading at a premium to the company's book value. It also indicates that you could be overpaying for what would be left if the company went immediately bankrupt.
What is the justified price-to-book ratio for CFA? ›
The justified P/B ratio tells us what the company's P/B ratio should be, if the company's shares are fairly valued. If the ROE exceeds the cost of equity, then the P/B ratio of a company should be greater than 1, i.e. company creates value for its shareholders.
Is price-to-book ratio the same as market to book ratio? ›
The market-to-book ratio, also called the price-to-book ratio, is the reverse of the book-to-market ratio. Like the book-to-market ratio, it seeks to evaluate whether a company's stock is over or undervalued by comparing the market price of all outstanding shares with the net assets of the company.
How do you interpret price ratio? ›
That is, the P/E ratio shows what the market is willing to pay today for a stock based on its past or future earnings. A high P/E ratio could signal that a stock's price is high relative to earnings and is overvalued. Conversely, a low P/E could indicate that the stock price is low relative to earnings.
What is a good p/s ratio? ›
While the ideal ratio depends on the company and industry, the P/S ratio is typically good when the value falls between one and two. A price-to-sales ratio with a value less than one is better.
What is a good PB ratio today? ›
Conventionally, a PB ratio of below 1.0, is considered indicative of an undervalued stock. Some value investors and financial analysts also consider any value under 3.0 as a good PB ratio. However, the standard for “good PB value” varies across industries.
Is 2 PB ratio good? ›
What is a Good Price to Book Value Ratio? Value investors often prefer values lower than 1.0, which suggests that an undervalued stock may have been found. The benchmark for certain value investors, however, may frequently be equities with a less strict P/B value of less than 3.0.
A P/B ratio below "1" indicates an undervalued stock, while the PB ratio over 1 indicates that the share is being sold at a premium.
Which is better, PE or PB ratio? ›
High PE can indicate high future growth expectations; low PE may suggest undervaluation. Low PB can suggest undervaluation, high PB may signal overvaluation or growth expectations. Can be influenced by non-operational factors and market sentiment. More stable, based on tangible book value of the company.
What is a bad price book ratio? ›
A bad price to book ratio a company can have is anything above 1. If a company has a P/B ratio of above 1, the company's share price is considered overvalued and not a good investment.
What is the formula for price-to-book ratio? ›
The price to book ratio (P/B) is calculated by dividing a company's market capitalization by its book value of equity as of the latest reporting period. Or, alternatively, the P/B ratio can also be calculated by dividing the latest closing share price of the company by its most recent book value per share.
What is a good PE ratio? ›
As far as Nifty is concerned, it has traded in a PE range of 10 to 30 historically. Average PE of Nifty in the last 20 years was around 20.* So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.
What is a good peg ratio? ›
What Is Considered to Be a Good PEG Ratio? In general, a good PEG ratio has a value lower than 1.0. PEG ratios greater than 1.0 are generally considered unfavorable, suggesting a stock is overvalued. Meanwhile, PEG ratios lower than 1.0 are considered better, indicating a stock is relatively undervalued.
What is price-to-book ratio CFI? ›
Price to Book Ratio Formula (P/B)
The P/B ratio is calculated by dividing market capitalization by the equity book value. Book value represents the value of assets and liabilities at the date they are reported in a company's financial statements.
What is the fundamental price to sales ratio? ›
The price-to-sales ratio (Price/Sales or P/S) is calculated by taking a company's market capitalization (the number of outstanding shares multiplied by the share price) and divide it by the company's total sales or revenue over the past 12 months. 1 The lower the P/S ratio, the more attractive the investment.
What is the price-to-book ratio for financial institutions? ›
The average P/B ratio for banking firms, as of the first quarter of 2021, is approximately 1.28. P/B is sometimes calculated as an absolute value, dividing a company's total market capitalization by the book value from the company's current balance sheet. The calculation is sometimes done on a per-share basis.
