Price To Book Ratio, often simply referred to as P/B Ratio, can be used to make a comparison between the current market price of a stock and the total book value of all the assets that company has on the balance sheet. The P/B ratio is one of the measures you can use when evaluating the fundamentals a stock.
While P/E Ratio can help you find value stocks based on earnings, Price To Book Ratio allows you to look for value stocks by finding companies that are not heavily overvalued compared to what their assets are worth. Understanding the P/B ratio can give you an idea of where a company should be at, considering its assets, as well as provide you with insight into whether the company is likely to recover if its price is currently slumping a little bit.
How is P/B Ratio Calculated?
Price To Book Ratio can be calculated as the total price of all outstanding shares (market capitalization) divided by the total book value of that company’s assets. You can also calculate P/B Ratio as the price per share divided by the book value per share. Either way will give you the same ratio, just a matter of what information you’re looking at: the entire total or the per share value.
Another thing to keep in mind with calculations like this is that what would be considered a low Price To Book Ratio for one sector might not be for another. So compare stocks within the same type of industry when value investing.
What Does the Price to Book Ratio Mean?
So what does a P/B Ratio of 1.0 really mean? It is a way of saying that things are basically in balance. It makes a good point of reference, even though the book value of assets might actually be different than the market value. One way to look at “book value” is to consider it as the original price of an asset, after it has been reduced by amortization or depreciation. When your ratio is less than 1.0, it means the stock could be undervalued, and might make a good bargain. An investment that has a P/B above 1.0, it means that the stock is probably overvalued… and may not be a good deal.
A ratio of 0.75 means that you can actually buy shares in the company for less that the value of all its assets. At first glance, it appears to be a decent value. However, P/B ratio isn't everything. Keep in mind that, with any value calculation, sometimes stocks are low for good reason. A low Price To Book Ratio can mean that the company is in trouble and you should look further into whether the stock truly is a “value”.
While there P/B ratio isn't perfect, it can provide you with a point of reference that you can use when comparing different investment options.