Price-to-Book (P/B) Ratio

What Is Price-to-Book Ratio?

Price-to-book ratio is a metric that values a company based on its market price relative to its net assets, typically calculated on a per-share basis. It's comparable to other ratios, for example, price-to-earnings in that it is one common way investors try to determine whether a company is undervalued or overvalued.
The ratio is used fundamentally for esteeming publicly traded companies since market prices, as well as their assets and liabilities, are publicly available.

How Do You Calculate Price-to-Book Ratio?

Computing the ratio might involve a few steps, depending on the availability of information. Companies might provide their book value of equity, or what is known as shareholders' equity, on the balance sheet of their quarterly or annual filing of their financial statement to the Securities and Exchange Commission. Book value of equity, or simply book value, may likewise appear on data provided by third-party financial data providers like Bloomberg.
The fundamental method for working out price-to-book ratio is to divide market capitalization by book value.
Computing on a per-share basis involves a few steps, but the ratio works the same way. Divide market capitalization by the number of shares outstanding. Then, divide book value by the number of shares outstanding. Separating the market capitalization quotient by the book value quotient will result in the P/B ratio.
Below is a table of price-to-book ratios of the 10 biggest companies on the S&P 500 by market value based on their financial statements from the end of the third quarter of 2021.

The most effective method to Interpret Price-to-Book Ratio

A company's P/B ratio can indicate whether its stock is undervalued or overvalued relative to its book value. A ratio of 1 or less would indicate that a company's stock is valued at or below book, and it would be considered undervalued. A low ratio (or a ratio of 1) suggests that the value of a company's net assets (or shareholder equity) is less than or equivalent to the stock price. In other words, on the off chance that the company were to be sold, its net assets would sell at the same price as its total stock (market capitalization). Conversely, a higher ratio would indicate that the company is trading at above book value. Too high a multiple would mean that the company is overvalued.

Could Price-to-Book Ratios Be Compared by Industry?

Companies differ in their classification of assets, so when comparing companies' price-to-book ratios with each other, contrasting those and comparative types of assets is better. For example, comparing the ratio of a property developer to a crypto financer would be arbitrary because the property developer would have tangible assets as buildings and land, while the crypto firm would have intangible assets that can't be quantified in physical form.

What Are the Limitations of the Price-to-Book Ratio?

The ratio would be considered a lagging indicator because book value is typically historical data. Few analysts, let alone companies, would provide estimates for a future period or guidance. Investors could zero in on other ratios like price to estimated earnings, commonly referred to as the forward or leading price-to-earnings ratio. The forward P/E ratio provides a multiple for the valuation of a company based on its future earnings of a given period, normally one year ahead of the current fiscal or calendar year.

Highlights

• The P/B ratio measures the market's valuation of a company relative to its book value.
• The market value of equity is typically higher than the book value of a company.
• P/B ratios under 1 are typically considered strong investments.
• P/B ratio is used by value investors to identify potential investments.

FAQ

What Does the Price-to-Book Ratio Compare?

The price-to-book ratio is one of the most widely-used financial ratios. It compares a company's market price to its book value, essentially showing the value given by the market for each dollar of the company's net worth. High-growth companies will often show price-to-book ratios well above 1.0, whereas companies facing severe distress will infrequently show ratios below 1.0.

What Is a Good Price-to-Book Ratio?

What considers a "great" price-to-book ratio will depend on the industry in question and the overall state of valuations in the market. For example, between 2010 and 2020 there was a steady rise in the average price-to-book ratio of the technology companies listed on the Nasdaq stock exchange, generally tripling during that period.An investor assessing the price-to-book ratio of one of these technology companies could hence choose to accept a higher average price-to-book ratio, as compared to an investor taking a gander at a company in a more traditional industry in which lower price-to-book ratios are the standard.

Why Is the Price-to Book Ratio Important?

The price-to-book ratio is important because it can help investors understand whether the market price of a company seems reasonable when compared to its balance sheet. For example, on the off chance that a company shows a high price-to-book ratio, investors could check to see whether that valuation is justified given other measures, for example, its historical return on assets or growth in earnings per share (EPS). The price-to-book ratio is additionally frequently used to screen potential investment opportunities.