What is P/B ratio? (Complete Details)

In this article, we get an in-depth understanding of ‘What is PB ratio in stock market?’, ‘What do low PB ratio stocks mean?’, and more!

What is PB Ratio?

• The price to book ratio is also called the P B ratio, where Price is the current market price of the stock and book is its book value per share.
• P/B in stock market compares the market value and book value of the company. This comparison demonstrates the difference between a company’s market value and book value.
• A stock’s market value is a forward-looking metric that reflects a company’s future cash flows. The market value equals the current stock price of all outstanding shares. It is the price that the market thinks the company is worth.
• A company’s book value is the value of a company’s net assets expressed on the balance sheet. It is the difference between the balance sheet assets and balance sheet liabilities. And it is an estimation of the value if the company liquidated its assets.

Price to Book Value Ratio Formula

Mathematically, we can calculate the P/B ratio simply by dividing the current closing price of the share by the latest quarter’s book value per share.

P/B ratio = [ Market Price per share / Book Value per share ]

Where,

• The Market Price per share = Current stock price that the company is being traded at on the open market.
  • The Book Value per share = [ Book value of company / Total No. of shares outstanding ]
  • Book Value of company = Net Assets of the company excluding intangible assets

Thus, Book Value of company = Total Assets – Intangible Assets – Liabilities

Example

To explain the calculation part, consider an example of our largest bank SBI, which has INR 3454752.00 Cr in assets. It is the sum of all line items in the assets section of the balance sheet. Here is the sum of cash, balances, investments, fixed assets and other assets. Also, we have INR 3235623.44 Cr in liabilities, which is the sum of current and non-current liabilities in the balance sheet. The book value of that company would be INR 219128.56 Cr (Assets – Liabilities). It is equal to the Owner’s book equity formula, as per the fundamental balance sheet equation of Assets = liabilities + Equity. 8,924,587,534 shares are outstanding; each share would represent INR 245.53 of book value. If each share sells on the market at INR 288.5 (as on March 11, 2019), then the P/B in share market would be = [ Current Market Price / Book Value per share ] = [288.5 / 245.53] = 1.18.

Balance Sheet of State Bank of India (values in INR Crores)

Balance Sheet of State Bank of India

Source: Moneycontrol.com

• P/B ratio = Stock Price / Book Value per share
• Book value = Rs 3,454,752.00 Cr– Rs 3,235,623.44 Cr= Rs 219,128.56 Cr (note that this is the same as owners’ equity)
• Book Value per Share = [ Rs 219,128,5600000 / 8,924,587,534 ] = INR 245.53
• P/B Ratio = [ 288.5 / 245.53 ] = 1.18x

How to use the P/B ratio?

• Investors express the price-to-book value ratio as a multiple showing ‘how many times a company’s stock is trading per share compared to the company’s book value per share. Thus, it is an indication of how much shareholders are paying for a company’s net assets.
• P/B ratio is beneficial when valuing companies composed of primarily liquid assets, such as finance, investment, insurance, and banking firms. It should not be used for companies with sizable R&D expenditure or firms with a large no. of fixed assets. It is because the fixed long-term assets are reported as historical assets. If those historical prices vary significantly with the market prices, book value can differ dramatically from market value.
• The P/B ratio will not work well in the service sector. For example, for IT and consulting companies where the primary assets are human resources, P/E is the proper valuation multiple. So, both PE and PB ratio have their significance.
• P/B ratio is beneficial for value investors, who are always behind the stocks trading below the intrinsic value.

Analysis of P/B ratio

Now that we know the PB ratio meaning, let’s undertsand what is a good P B ratio and a bad PB ratio.

• If P/B is less than one, it indicates that the market believes the asset value is overstated or that the company is earning an abysmal (even negative) return on its assets.
• A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal. Any other good news may already be accounted for in the price and may represent that the stock is overvalued.
• Companies with low PB ratio stocks indicate that their stock is undervalued. There can be two cases: either the market believes that the asset value is overstated, or the company is earning an abysmal (even negative) return on its assets. So, it could also mean that something is fundamentally wrong with the company.
• Significant discrepancies between P/B and Return on Equity (ROE), a key growth indicator, can sometimes red flag companies. Because If a company’s ROE is growing, its P/B ratio should be doing the same. Overvalued growth stocks frequently show a combination of low ROE and high P/B ratios.

Limitations

• The P/B ratio is primarily applicable when looking at capital-intensive or financial businesses, who have plenty of tangible assets on books. As for banks, most of the assets are recorded at market value. P/B has no use in sectors where there are very few tangible assets, as in the case of the service sector.
• Book value doesn’t offer insight into companies with high debt levels or sustained losses, such as infrastructure companies. Debt can boost a company’s liabilities to the point where they wipe out much of the book value of its hard assets, creating artificially high P/B values.
• This method doesn’t consider dividends. Investors are almost always willing to pay more for shares that regularly and reliably issue a dividend.

Summary

• P/B ratio is a financial valuation tool used to evaluate whether the stock of a company is over or undervalued by comparing the price of all outstanding shares with the company’s net assets.
• In conclusion, we can say that P/B is an easy-to-use tool for identifying clearly under or overvalued companies.
• But, despite its simplicity, P/B doesn’t do magic. There are many other factors that this basic calculation doesn’t consider. The real purpose is to give investors a rough idea as to whether the sale price is close to what it should be.
• We recommend that all investors understand the advantages and disadvantages of the ratio in detail before using it for making investment decisions.