Price-to-Book Ratio (P/B Ratio)
Definition of 'Price-to-Book Ratio (P/B Ratio)'
The price to book ratio (otherwise known as P/B ratio) is the comparative analysis of the cost of a company’s stock (market value) to its value (book value) if the company were to dissolve.
TheStreet Explains ‘Price-to-Book Ratio (P/B Ratio)’
The price to book ratio is used to evaluate a company’s vitality. Investors use this ratio to determine if the return on their investment would be intelligent and financially fruitful. For investors looking for a bargain, they use the P/B ratio to seek low-priced stocks that may be undervalued and are trading for less than their book value. However, a low price could also mean something is wrong with the company and the investor should steer clear. Overall, the P/B ratio gives investors insight into a stock that will grow at a realistic price.
To calculate the price to book ratio, also known as the price to equity ratio, divide the stock price by the total assets, minus intangible assets and liabilities. A P/B ratio under 1 is considered low, which may indicate certain negative aspects about a company. A low P/B ratio is a red flag and means the company will most like have a low ROE (return on equity) and/or ROA (return on assets).
Also, something to consider is the industry as a whole. Some industries have low P/B ratios by the nature of the business. The P/B ratio does not take intangible assets or intellectual property into consideration, which may be of significant value to a certain company. Companies such as technology businesses that may have substantial assets, mainly in intellectual property, may not have a P/B ratio that accurately reflects the company’s financial health.
Although the price to book ratio can provide insight, it does have some drawbacks. One issue is that P/B ratio doesn’t really address all companies, mainly those that have a considerable amount of assets on the ledger sheet. The P/B ratio is best used with companies that have a lot of assets such as financial institutions and manufacturers. Although analysts turn to the price to book ratio as a reliable method of measure, investors are warned to use it along with other valuation metrics in order to achieve a clear, more accurate picture.
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By Lenny Dykstra | 12/30/08 - 02:38 PM EST