So as promised, today I’m going to write a bit about what I know on price to book ratio (P/B ratio). Much like P/E ratio, P/B ratio is an indicator that can be used by value investors to signal if a company is under or overvalued. Also like the P/E ratio, it should not be used alone to judge a value of a company, if a low P/B ratio consistently points us to an undervalued company, we’ll all be rich.
To calculate the P/B ratio you divide the price per share by the book value of the equity:
P/B ratio = Price per share/Book Value
Book value is the company’s assets minus its liabilities.
So from that formula, we can say that the P/B ratio compares the current market valuation of a company to the value of the company’s assets. A P/B ratio of less or equal to 3 typically interests value inventors because it could mean that the stock is selling at a discount to its fair value.
A company’s P/B ratio can be calculated including or excluding its intangible assets and goodwill. A P/B ratio calculated without intangible assets and goodwill should technically be called price to tangible book value.
Personally, I like to look at the price to tangible book value to get an idea of what might happen if the company that I'm deciding to invest in goes bankrupt. Obviously when a company goes bankrupt, one of the things they can do is to break up the company into little packages and sell off their assets in blocks to other people. By looking at the P/B ratio I sorta get an idea of how much of a premium above the company’s assets I’m paying.
Thanks for reading, hope you’ve learnt something from the post. Is the P/B ratio one of your favorite indicators? Or you don’t even look at it. Do leave a comment or send me an email if you have anything to add. Next week I’ll write about my first trade in 2013. Have a great week!