Posted in Finance, Accounting and Economics Terms, Total Reads: 718
Definition: Price-to-Book (P/B) Ratio
Price-to-book ratio is a financial measure of the company’s stock price relative to its book value. It measures whether the amount spent (stock price) on the company was worth it, based on what would be left of the company when it goes bankrupt (book value). P/B ratio is calculated as:
The P/B ratio helps one in understanding whether a company is overvalued or undervalued. Companies with lower P/B ratio are usually undervalued. This is because an investor is able to purchase stock of the company at a cheap price that is lesser than the value quoted on books. Even though low P/B companies are cheap buys, they usually have a negative connotation attached. The negative outlook arises from the apprehension that a company trading below book value could possibly be earning negative returns or going close to bankruptcy.
On similar lines, companies with a high P/B ratio are considered overvalued. Any new positive information about the company would not really appreciate the share price, as the price is already high. An investor thus needs to analyze the P/B ratio properly, anchoring it to the average industry P/B ratio, before making any investment decision.
P/B ratio is more relevant for capital intensive or tangible asset heavy businesses. This is because book value of a company does not account for any intangible assets. Hence P/B ratio will not play a significant role in intangible asset oriented industries like IT services.
(Figures in USD mn.)
Total Assets 1200 Total Liabilities 700
Tangible Assets 1000
Intangible Assets 200
Book Value = 1000 (Tangible Assets) – 700 (Total Liabilities) = USD 300 mn.
Say, the market capitalization (Number of outstanding shares x share price) of the firm is around USD 420 mn.