What is the price-to-book ratio – P/B Ratio Explained with Examples

• By comparing a company's market price to its book value, the P/B ratio helps investors determine whether a stock is cheap (<1), reasonably priced (1), or expensive (>1).

• It is less helpful for tech or startups with intangible assets, but it is effective for industries with substantial assets, such as manufacturing, banking, and real estate.

• P/B should not be used alone; when combined with other metrics, such as P/E and ROE, it provides a more complete picture of whether a stock is actually worth purchasing.

The company's stock price is evaluated in relation to its book value, the residual value after all debts have been settled, using the Price-to-Book (P/B) ratio. A lower P/B ratio may indicate an undervalued stock, suggesting it could be an attractive investment opportunity, whereas a higher P/B ratio might signal overvaluation.

Understanding P/B Ratio with Aman’s Example:

Imagine Aman buys a company with:
 

• Assets (what it owns): ₹10,00,000
• Liabilities (what it owes): ₹4,00,000
• Book Value (Assets - Liabilities): ₹6,00,000
• Market Value (what people pay for it): ₹9,00,000

P/B Ratio = Market Value / Book Value = 9,00,000 / 6,00,000 = 1.5

A P/B of 1.5 means investors pay ₹1.5 for every ₹1 of the company’s book value.

Table:

Key Differences Between Market Value & Book Value.
 

This table helps you see why P/B matters; it checks if a stock’s price is fair.

Aman and other investors employ the Price-to-Book (P/B) ratio as a fundamental metric to evaluate the attractiveness of a stock for investment purposes. Generally, an undervalued stock is identified by a P/B ratio below 1, suggesting it may be trading at a price less than its book value. 

Conversely, a higher Price-to-Book (P/B) ratio may indicate that a stock is overvalued or trading at a premium. This article offers a professional overview of how the P/B ratio is utilized in stock analysis.

How to Calculate the P/B Ratio?

The price-to-book (P/B) ratio is a crucial metric used by investors such as Dev to evaluate whether a stock is correctly valued. But how exactly is this ratio determined?

Let's simplify it with a simple example.

How Dev Calculates the P/B Ratio for XYZ Company

Dev wants to invest in XYZ Ltd. and checks its P/B ratio. Here’s how he does it:

Step 1: Find the Book Value

Book Value = Total Assets – Total Liabilities

• XYZ Ltd. has:
  • Total Assets = ₹10,00,000
  • Total Liabilities = ₹4,00,000
  • Book Value = ₹10,00,000 – ₹4,00,000 = ₹6,00,000

Step 2: Calculate Book Value per Share

Book Value per Share = Book Value / Total Shares

• XYZ Ltd. has 1,00,000 shares.
• So, Book Value per Share = ₹6,00,000 / 1,00,000 = ₹6 per share.

Step 3: Check the Market Price

• The current stock price of XYZ Ltd. is ₹9 per share.

Step 4: Calculate the P/B Ratio

P/B Ratio=Market Price per Share(₹9)/Book Value per Share(₹6)=₹9/₹6=1.5P/B

Meaning: Dev is paying ₹1.5 for every ₹1 of XYZ Ltd.’s book value.

Table:

This Table shows the Key Components of P/B Ratio Calculation:
 

This table helps you see how each number fits into the P/B ratio formula.

Why Does This Matter for Dev?

Now Dev knows that XYZ Ltd. has a P/B ratio of 1.5, meaning the stock trades at 1.5 times its book value.

• P/B < 1: Stock may be undervalued (good deal).
• P/B > 1: Stock may be fair or overpriced.

Since XYZ Ltd. has a Price-to-Book ratio of 1.5, Dev evaluates whether the company's growth rate justifies this valuation. Subsequently, he should benchmark it against competitors to make an informed decision.

To calculate the Price-to-Book (P/B) ratio professionally, divide the stock's current price by its book value per share. Mastering this method enables Dev to identify undervalued stocks and avoid overpaying. Are you ready to apply this technique yourself? Choose a stock and compute its P/B ratio now.

What Does the P/B Ratio Tell You?

A company's book value, representing its intrinsic worth after accounting for liabilities, is evaluated against its market valuation using the Price-to-Book (P/B) ratio. A high P/B ratio could imply overvaluation, whereas a low P/B ratio might indicate a potentially undervalued investment opportunity.

Example:

Shikhar is interested in purchasing stocks but aims to avoid overspending. The Price-to-Book (P/B) Ratio serves as an essential metric in this context. It helps determine whether a stock is overvalued, fairly valued, or undervalued relative to its intrinsic worth.

How Shikhar Uses the P/B Ratio

Shikhar is analysing ABC Bank:

• Stock Price (Market Value per Share): ₹120
• Book Value per Share: ₹100
• P/B Ratio = ₹120 / ₹100 = 1.2

Since ABC Bank’s P/B is 1.2, Shikhar sees that investors are paying ₹1.20 for every ₹1 of the bank’s book value.

Table:

This table shows what different P/B ratios indicate:
 

This table helps Shikhar quickly assess whether a stock is a good deal.

Much like a price tag, the P/B ratio functions as a critical indicator of whether an investment is appropriately valued. To identify promising opportunities and avoid overpaying for stocks, it is advisable to analyze the P/B ratio as part of your next investment decision process. 

Are you prepared to analyse stocks like Shikhar?P/B ratio calculations should begin now! 

Conclusion

The price-to-book (P/B) ratio serves as a valuable tool for investors to assess whether they are paying a fair price relative to a company's intrinsic value. As noted by Shikhar, a P/B ratio below one can suggest a potentially advantageous investment opportunity. 

In contrast, a high P/B ratio might indicate that the market is pricing in significant expectations for future growth. It's essential to acknowledge that this ratio is most relevant for asset-intensive industries, such as banking and manufacturing, and may not be as applicable to startups or technology companies.

FAQs

Should I consider selling a stock if its Price-to-Book (P/B) ratio becomes excessively high? 

It's important not to rely solely on the P/B ratio. Evaluate whether the company’s growth prospects substantiate the elevated ratio. Keep in mind that some leading companies maintain high P/B ratios over extended periods.

Can P/B be negative? What does that mean?

Yes, if liabilities surpass assets (resulting in a negative book value), it is advisable to avoid such situations unless they are part of a temporary crisis with a clear recovery plan.

How frequently should I monitor P/B ratios? 

It is advisable to review them when researching new stocks or if a significant change in the price of a held stock occurs. For long-term investments, conducting quarterly evaluations suffices.

Does Price-to-Book (P/B) Ratio Perform Effectively During Market Crashes?

Yes, low P/B stocks can represent attractive bargains during market downturns. However, it's essential to thoroughly verify that the company's fundamentals remain strong and it isn’t fundamentally broken despite the low valuation.

Why do two similar companies exhibit different Price-to-Book ratios? 

Investors may favour one over the other due to superior management, lower debt levels, or greater growth prospects. However, the P/B ratio alone does not provide a complete picture of a company's valuation.

Which is more advantageous, the P/B ratio or the P/E ratio? 

It is essential to consider the context when evaluating company metrics. Utilize the Price-to-Book (P/B) ratio for asset-intensive businesses and the Price-to-Earnings (P/E) ratio for companies focused on profitability. Experienced investors analyze both indicators comprehensively to make well-informed investment decisions.
 

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