If you are baffled by the ratios in the stock market, you are not alone. You can easily find a whirlwind of figures and ratios. Some of them, such as P/E and market cap are easily explained and understood. However, you might be able to find more value from less known ratios such as Price/Book.
How It Is Calculated
The first step is to calculate book value per share. Book value is the total shareholder’s equity (assets minus liabilities) less preferred stock. This is the accounting value of the company. In theory, the book value is the most conservative valuation method for a company. It is the net value of the company’s assets if it were to stop operating today.
Book Value = (Assets – Liabilities) – Preferred Stock
To calculate book value per share, simply divide book value by the number of common shares outstanding.
Book Value Per Share = Book Value / Shares Outstanding
Next divide the share price by the book value per share to find the Price/Book Ratio.
Price/Book Ratio = Share Price / Book Value Per Share
What It Really Means
This ratio tells you if the stock price of a company is significantly higher than the value of tangible assets of a company. If the stock price is higher, the company must have a solid business model to contribute value to the share price. If a company has a bad business model, the stock price should be closer to the book value per share.
How I Use It
Warren Buffet is known for “value investing.” Part of his analysis is to look at the underlying value of a company’s assets. If the stock price is lower than the book value per share, investors are practically guaranteed a gain even in the worst case scenario.
When I am looking for investment opportunities, I can use a stock screener to find BV/Share investment opportunities where the ratio is very low. If the BV/Share is less than 1.0, investigate why the company’s stock is performing so poorly. It is almost certainly worth more than its current value if the book value is higher than the share price.
If the book value per share is incredibly high, it does not necessarily mean a company is a bad investment. Software companies, for example, usually do not have many tangible assets. However, a low BV/share could indicate a company is a good investment.
Want to Know More?
Be sure to read my in-depth guide to how the stock market works to learn everything you need to know to get started with investing.
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6 thoughts on “What Price/Book Ratio Means in Investing”
Interesting post. I’ve always looked at the ratio but never really knew what was behind it
Glad you could learn something useful.
I favor P/B the most, followed in a close second place by ROE. Generally, I don’t want to pay more than book for a company, but if the ROE is good enough (and growth is in the picture) I’m willing to pay up.
Third favorite ratio is (following downturns) how much the company has spent to maintain its advantage relative to its peers. I like to own companies that know the power of advertising that can firm up their equity position in people’s minds while their competitors cut down on prices, reduce adspend, or make other short-run decisions that affect long-term cash generation.
Interesting perspective. Thanks for sharing. I find the stocks with very low P/B ratios are few and far between. How do you decide what to buy with a P/B over 1?
Stocks with a P/B ratio of <1 are usually microcaps. That's not necessarily a bad thing for me–I prefer them.
For microcaps, I like to see that they have some growth potential, and also that they have the lowest possible debt that is reasonable. With small firms, you start getting into bank debt, which is unfortunately callable.
Across the board, though, I want to see that the company isn't just a middle man. Anyone can buy something and sell it for a profit–and its easy to get squeezed. Rather, I want to see that they do something that is economically difficult to replicate.
Example: A golf stock I own produces golf clubs. Doing that requires far more capital, expertise, and time than…say, opening up a golf retailing store.
Interesting strategy. I generally stay away from small caps (outside of an ETF) let alone invest in microcaps. That seems a bit too risky for my taste. But, it does make sense that a micro with a P/B less than 1.0 is “risk free” in a sense.
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