Investing for Beginners

Investment Dictionary

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P/B Ratio

P/B (P/Bv or price-to-book) ratio shows how expensive stock is compared to its books value. Company’s book value (also called equity, capital, shareholders funds etc.) is equal to company’s total assets less total liabilities.

Formula (Calculation)

P/B = share price* / book value per share**

* It is the last price of the share on the stock exchange.

** Book value attributable to one share.

Simplified calculation (may be applied only to one share class):

P/B = market capitalization / shareholders’ equity **

** Book value attributable to shareholders (less minority shareholders’ equity).

When calculating P/B ratio, few aspect are needed attention. Currency of the share price and book value has to coincide. If numbers in balance sheet are provided in thousands or millions, you should adjust calculations to that. The last data are the best, but if you want more accuracy, audited results have the advantage.

If you know that some assets (tangible or intangible) doesn’t have real value in the market, but such assets have high value in balance sheet, you can make adjustments and impair book value by that amount before calculating P/B ratio.

Ratio interpretation:

This ratio is an easy one to calculate, but not an easy to make it work. Most of the times, when company has high ROE (that means is very profitable) P/B ratio will be useless. In such cases price-to-book is very high (>2-3), and doesn’t provide any interesting information.

However, P/B ratio might interesting when is very low. We may start to pay attention to this ratio when it is lower than 1 for selected investment. P/B ratio in many cases may be 0.3, 0.2, 0.1 or even lower. Such numbers are low for P/B, but low ratio doesn’t necessarily mean that stocks with low book value ratio is a proper investment.

P/B ratio should show what return investors could get from company in case of liquidation. But it is not the only case. Return may come in vary ways, but the main thing is to be sure about the real value of assets, because book value might be very far from it.

Price-to-book ratio is popular for banks’ valuation, because banks have high asset turnover and their assets are more liquid and more close to market value.

If you want to find cheap stocks that would be good investments, you have to calculate more valuation multiples, but you can’t rely on one ratio (P/B) when making investment decision.