One financial valuation statistic used to compare the current market value of a company to its book value is the Price to Book Ratio (also known as Market to Book Ratio). The book value is equal to the company’s net assets and is derived from the balance sheet. In other words, the ratio is used to compare a company’s available net assets to the price at which its shares are sold. In this article, we explain the price-to-book ratio, and what are the ratios by industry.
Price to book ratio or P/B ratio
The price-to-book ratio (P/B ratio) is a method of comparing a company’s market capitalization to its book value. It is computed by dividing the stock price per share by the book value per share of the corporation (BVPS). The book value of an asset is the same as its carrying value on the balance sheet, and corporations determine it by subtracting the asset’s cumulative depreciation. Price-to-book ratios of high-growth corporations are frequently above 1.0, but ratios of distressed companies are occasionally below 1.0.
What is the price to book ratio or P/B ratio?
To compare a company’s market capitalization to its book value, the price-to-book ratio (P/B ratio) is used. It is computed by dividing the stock price per share by the book value per share of the corporation (BVPS). The P/B ratio is a ratio that compares a company’s market value to its book value.
How does the price to book ratio work?
The ratio of a company’s market value (share price) to its book value of equity is known as price-to-book value (P/B). The book value of equity, on the other hand, is the balance sheet worth of a company’s assets. The difference between the book value of assets and the book value of liabilities is known as the book value. The price-to-book value ratio is used by investors to determine if a stock is appropriately valued. A P/B ratio of one indicates that the stock price is equal to the company’s book value. In other words, strictly from a P/B basis, the stock price would be regarded as appropriately valued.
How does the price to book ratio help in business valuation?
It depicts the link between an organization’s total value of outstanding shares and its book value of equity. The P/B ratio, among other indicators, is commonly used by value investors to assess if a company’s stocks are overpriced or undervalued.
Why is the price to book ratio important for investors?
The price-to-book value ratio is used by investors to determine if a stock is appropriately valued. A P/B ratio of one indicates that the stock price is equal to the company’s book value. In other words, strictly from a P/B basis, the stock price would be regarded as appropriately valued. A high P/B ratio indicates that the stock price is overpriced, whereas a low P/B indicates that the stock price is undervalued. The P/B ratio, on the other hand, should be compared to firms in the same industry. Some industries have a greater ratio than others. As a result, it’s critical to compare it to organizations with similar asset and liability structures.
How does the price to book ratio different from other valuation metrics?
The price-to-book ratio can reveal whether or not a stock is cheap. P/B can help you decide which stock is the greatest bargain at any given time when you’re comparing two firms with equal growth and profitability. In general, the lower a company’s price-to-book ratio is, the better its value. This is especially true if a stock’s book value is less than one, implying that it is trading for less than its assets are worth.
For value investors, buying a company’s shares for less than book value might provide a “margin of safety”. An extremely low P/B ratio, on the other hand, might be an indication of danger for a firm, thus it should be utilized as a part of a comprehensive stock study. For a corporation with inconsistent or negative earnings, the price-to-book ratio can be particularly beneficial; other typical measures, such as the price-to-earnings ratio, aren’t as relevant in these instances. Because many bank stocks have wildly fluctuating profits, the P/B ratio might provide a more accurate view of their relative worth.
Limitations of price to book ratio
One of its most significant flaws is that it ignores intangible assets such as goodwill, resulting in a low book value and a high artificial price/book ratio. The book value of an object is based on the item’s initial purchase price rather than the current market price, resulting in measurement discrepancies.
- Use in capital intensive businesses – Operating leverage, which is the ratio of fixed expenses to variable costs, is common in capital-intensive businesses. As a result, capital-intensive enterprises require a large amount of output to generate a sufficient return on investment. This also implies that little changes in sales can result in significant changes in earnings and return on invested capital.
- Ignores intangible assets – Intangible assets such as a company’s brand name, goodwill, patents, and other intellectual property are not included in book value. As a result, it has little value for service-based businesses with little tangible assets. For example, Microsoft’s intellectual property, rather than its physical assets, determines the majority of its asset worth. As a result, the market value of Microsoft’s stock differs significantly from its book value.
- Doesn’t offer insights into the high debt level – Book value can’t tell you whether a company has a lot of debt or has been losing money for a long time. Debt may inflate a company’s obligations to the point that they wipe out a significant portion of the book value of its hard assets, resulting in inflated P/B values. P/B ratios understate the assets of highly leveraged corporations, such as cable and cellular telecommunications companies. Book value might be negative and worthless for organizations with a streak of losses.
- Ignores real asset value – Non-operating difficulties might have such an influence on book value that it no longer reflects the true worth of the assets. When assets are aging, the book value of an asset represents its initial cost, which is not useful. Second, if the assets’ earnings power has grown or decreased after they were bought, their worth may diverge dramatically from their market value. The book value of assets may potentially be less than the current market value due to inflation–or rising prices.
How to calculate the price to book ratio or P/B ratio?
Divide a company’s market capitalization by its book value of equity as of the most recent reporting period to get the price-to-book ratio (P/B). The P/B ratio may also be determined by dividing the company’s most recent closing share price by its most recent book value per share.
The formula of the price to book ratio is given below:
Assume the following information is available to a company:
- $90 million in assets
- $60 million in liabilities
- The number of outstanding shares is ten million.
- $5 per share is the current stock price.
We begin by determining the book value and book value per share of the firm. $30 million in book value ($90 million in assets minus $60 million in liabilities). The book value per share is $3 (book value of $30 million divided by 10 million shares).
($5 stock price / $3 book value per share) Equals P/B ratio = 2.
To put it another way, the stock is worth twice its book value. The P/B ratio’s justification depends on how it compares to its value in previous years and to the ratios of other firms in the same sector.
Low price to book ratio VS high price to book ratio
The P/B ratio measures how many market participants value a company’s stock in comparison to its book value. The market value of a stock is a forward-looking indicator of a company’s future cash flows.
The book value of equity is an accounting metric that incorporates prior stock issuances, increased by any profits or losses, and lowered by dividends and share buybacks. The price-to-book ratio compares the market value of a corporation with its book value.
A company’s market value is calculated by multiplying its share price by the number of outstanding shares. A company’s net assets are its book value. To put it another way, if a firm liquidated all of its assets and paid off all of its debt, the value left would be its book value.
High price to book ratio
A P/B ratio larger than one indicates that the stock price is trading at a premium to the book value of the firm. A price-to-book value of three, for example, suggests that a company’s stock is selling at three times its book value.
For decades, value investors have preferred the price-to-book (P/B) ratio, which is frequently utilized by market analysts. Any P/B figure less than 1.0 is traditionally regarded as a positive P/B value, suggesting a possibly inexpensive company. Value investors, on the other hand, value investors frequently investigate equities with a P/B value of less than 3.0.
Price to book ratio by industry
For decades, value investors have preferred the price-to-book (P/B) ratio, which is frequently utilized by market analysts. To calculate the price to book ratio, investors must multiply the current market price of the company’s stocks by the total number of outstanding shares. Value investors use the price to book ratio to determine whether firms’ stocks are cheap, so here’s a table depicting the link between price to book ratio and industry.
|Industry||Average of Price to Book Value|
|Finance: Consumer Services||18.1856|
|Assisted Living Services||16.0675|
|Other Specialty Stores||14.7784|
|Retail: Computer Software & Peripheral Equipment||14.4226|
|Other Consumer Services||14.3579|
|Biotechnology: In Vitro & In Vivo Diagnostic Substances||14.1128|
|Computer Software: Programming Data Processing||13.8900|
|Air Freight/Delivery Services||12.9142|
|Computer Software: Prepackaged Software||12.4016|
|Internet and Information Services||10.6556|
|Biotechnology: Biological Products (No Diagnostic Substances)||10.6538|
|Managed Health Care||10.0818|
|Biotechnology: Electromedical & Electrotherapeutic Apparatus||9.9972|
|Diversified Commercial Services||9.5465|
|Department/Specialty Retail Stores||8.3397|
|Real Estate Investment Trusts||8.2984|
|Services-Misc. Amusement & Recreation||7.7852|
|Biotechnology: Commercial Physical & Biological Research||7.5284|
|Radio And Television Broadcasting And Communications Equipment||7.3812|
|Consumer Electronics/Video Chains||7.1714|
|Biotechnology: Laboratory Analytical Instruments||6.7888|
|Service to the Health Industry||6.6516|
|Computer peripheral equipment||5.7814|
|Oil & Gas Production||4.5146|
|Ordnance And Accessories||4.1593|
|Trucking Freight/Courier Services||3.9839|
|Auto Parts: O.E.M.||3.8140|
|Trusts Except Educational Religious and Charitable||3.4895|
|Engineering & Construction||3.3168|
|Pollution Control Equipment||3.2313|
|Natural Gas Distribution||2.3069|
|Electric Utilities: Central||2.2359|
|RETAIL: Building Materials||2.1965|
|Other Metals and Minerals||2.0425|
|Integrated oil Companies||1.7340|
|Diversified Financial Services||1.4212|
|Accident &Health Insurance||1.1925|
Top 5 Price to book ratios
One of the most often utilized financial measures is the price-to-book ratio. It compares a company’s market price to its book value, basically displaying the market’s value for each dollar of net worth. Here is the table of price book ratios of different companies that showcase the number of shares that have been used further.
|Industry||Average of Price to Book Value|
|Finance: Consumer Services||18.1856|
Why Eqvista is a better choice for your 409a business valuation?
A 409A valuation is a procedure for valuing your firm in order to estimate the cost of its shares, which results in a valuation report. This report is a regulatory obligation for organizations that are planning to give their employees deferred remuneration. Get a 409A valuation service to value your company and reduce your risk! Eqvista is a prominent provider of 409A valuation services, and we would be delighted to assist you and your business. For your 409A valuation needs, Eqvista has you covered. Contact us now to learn more!