Price-To-Book Ratio | P/B Ratio Meaning, Formula, & Interpretation

Meaning – The price-to-book (P/B) ratio is a mathematically derived metric used in the valuation of financial securities. It measures a company’s market value relative to its book value. It is an important financial measure used specifically by long-term investors to find undervalued stocks with huge potential upside. 

What is the Price-to-Book (P/B) Ratio in the Share Market?

The price-to-book ratio, commonly known as the P/B ratio, is one metric that is widely accepted in the financial sector for the valuation of assets and financial instruments. It is a ratio that represents the relationship between a company’s market value and the book value. It is also calculated based on the current market price and book value per share (BVPS). To understand the importance of key metrics such as the P/B ratio, please look at the following example:

Let us say you are deciding to buy a car and are confused about which one to choose. To clear up this confusion you start comparing different cars based on various parameters such as mileage, top speed, and pricing. After analysing all the options based on these metrics, you make a final decision. 

Similarly, like the car-choosing process, investors in the stock market give huge weightage to key financial metrics like the P/B ratio value to analyse the publicly listed companies and invest their money in the best available option.

Objectives of the Price-to-Book (P/B) Ratio in Share Market

The primary objective of the P/B ratio is to help investors understand the relationship between a company’s current stock price or market value and its book value. By using this metric, stock market participants get an idea about the current value of a company relative to its book value of assets, using which they make an investment decision. 

1. Extensively used to identify undervalued companies which have growth potential.
2. The price-to-book (P/B) ratio is a valuation ratio used by value investors for valuing a company’s share. 
3. It represents the relationship between the market value and book value of a company. 

Price-to-Book (P/B) Ratio Formula & Calculations

Since we have understood the concept of the P/B ratio (price-to-book), let us know how it is calculated and its formulas. To calculate the P/B ratio, we need the below two values handy:

1. The market value of the company = Current market price per share X number of outstanding shares 
2. Company’s Book Value = [(Total assets – Intangible assets) – Total Liabilities)]

*If the company do not have intangible assets, then

Company’s book value = Total assets – Total liabilities

Once both the above values are calculated, we can proceed to the formula for calculating the price-to-book (P/B) ratio. The formula for the P/B ratio value is as follows:

P/B Ratio Formula = Market value of company / book value of company

Other than this formula, many investors prefer to track the P/B ratio value on the basis of the company’s current market price (CMP) per share and book value per share (BVPS). This is so because by using these values, investors can understand how much the share prices are changing in relation to the book value per share. The formula for the P/B ratio based on the share market price is: 

P/B Ratio Formula  = current market price (CMP) per share / book value per share (BVPS)

Example

There is a company, ABC Ltd., which manufactures steel and copper pipes for distinct applications in numerous industries. It is a listed company on the Indian stock market and has presented its financial statements for the Fiscal Year ending on 31st March 2023. The market price of ABC Ltd. shares is Rs 100. 

Here are the key extracts from the financial statements of the company ABC Ltd. 

Current Assets = Rs 20,00,000

Non-current Assets = Rs 15,00,000

Total Liabilities = Rs 15,00,000

Total Outstanding Shares = 10,000

As an investor, you want to analyse whether the company is overvalued or undervalued. Based on this analysis, you will be making your investment decision. Hence, you need to calculate the P/B ratio value of ABC Ltd. based on the above information. 

First, to calculate the P/B ratio, let us calculate the book and market values of ABC Ltd. 

Book Value = Total Assets – Total Liabilities 

= [(Non-Current Assets + Current Assets) – Total Liabilities]

= [(15,00,000 + 20,00,000) – 15,00,000]

= (35,00,000 – 15,00,000)

= Rs 20,00,000

Market Value = Current market price X Total outstanding shares 

  = 100 x 10,000

  = 1,00,000

P/B Ratio Formula = Market value of company/book value of company

  = 1,00,000/20,00,000 

  = 0.05

Interpretation of the Price-to-Book (P/B) Ratio

Every investor looks at the price-to-book value (P/B ratio) in their own way. However, one of the most basic interpretations of the P/B ratio value is the undervaluation or the overvaluation of security. 

When investors derive the price-to-book (P/B) ratio for a company, their main objective is to check whether the market is overpaying or underpaying for the stock. In case the market or, in simple terms, the demand for a particular share is more than its actual value, then it is right to conclude that the share is overpriced. The above interpretation of the P/B ratio helps investors to make the right investment decision in the stock market. 

Low P/B Ratio Meaning – A low P/B ratio, usually lower than 1, means that the stock is trading lower than its actual worth. It means that the underlying company of the stock might be facing difficulty, which has reduced the P/B ratio value. 

High P/B ratio Meaning – A high P/B ratio, usually higher than 1, reflects the overvaluation of a stock. This value indicates to the investors that a particular stock is trading at a higher value than its book or intrinsic value. 

• A lower P/B ratio indicates the undervaluation of a stock, whereas a higher P/B value tells that the stock is overvalued. 
• By understanding the actual valuation of stocks, investors can identify the right stock for investment.

Application of the Price-to-Book (P/B) Ratio

The applications of the price-to-book ratio can be summarised in the following points:

1. Valuation Tool – The price-to-book (P/B) ratio is a vital measure for finding the right valuation of a company or stock. It helps investors to analyse the market value of a share relative to its book value or net worth. By using the P/B ratio value, you can assess whether the company shares are undervalued or overvalued. 

2. Comparison Metrics – The P/B ratio is also helpful in peer-to-peer comparison of companies within a particular sector or industry of the stock market. Comparison of the P/B ratio of different companies helps investors streamline their research and investment procedure.  

3. Assessment of Financial Stability –  Another important usage of the P/B ratio is that it can provide insights into a company’s financial position. It allows investors to assess and understand how stable a company is in terms of its assets. 

Limitation of the Price-to-Book (P/B) Ratio 

The P/B ratio value, besides its many uses and benefits, does have a major drawback. If the price-to-book (P/B) value is used while analysing asset-light companies such as IT companies, it may provide false insights about the company’s true market value. 

Also, in calculating the price-to-book (P/B) ratio, a company’s book value is considered as the denominator, which is static and is based on past values, due to which the P/B ratio sometimes provides false insights. However, if used in combination with other metrics, such as the price-to-earnings ratio (PE ratio) and return on equity (ROE), the price-to-book (P/B) ratio becomes a game changer in company analysis and valuation.

• The primary drawback of the P/B ratio is that it may provide inaccurate information about the value of an asset-light company. 
• Secondly, the P/B ratio can also provide false signals because of the static nature of a company’s book value.

Price-to-Book Ratio (P/B ratio) VS Price-to-Earnings (P/E) Ratio

The price-to-book ratio (P/B ratio) and the price-to-earnings ratio (PE ratio) may sound similar to you, but they differ drastically in terms of use case and calculation. 

The price-to-earnings ratio is a very important metric for evaluating companies, similar to the P/B ratio, but the former considers the earnings per share of the company as a denominator, whereas the latter takes the book value as the denominator during calculation. Due to this difference in calculation, their interpretation also varies. 

Now let us have a look at how both these values are calculated: 

P/B Ratio Formula =  Market value of shares/book value of assets 

OR 

P/B Ratio Formula = current market price (CMP) per share/ book value per share (BVPS)

PE Ratio Formula =  current market price (CMP) per share/ Earning per share (EPS)

As you can see, the PE and P/B ratios will revert to different values for you because both of them have distinct bases for their calculation. 

• Price-to-earnings (P/E) and price-to-book (P/B) ratios are both used for the valuation of companies. 
• Both these ratios differ because of variations in their use case and derivation methods.

Also read: Price to Earnings (P/E) ratio – Defination and Formulas

Price-to-book Ratio (P/B ratio) VS Return On Equity (ROE)

As we have seen above, the PE and P/B ratios differ in various ways. Now let us understand how Return on equity (ROE), unlike the PE ratio, relates significantly to the P/B ratio. 

Return on equity is a very useful tool for analysing the financial performance of a company in terms of returns it generates for its investors. Return on equity (ROE) refers to the return that a company generates for each unit of its shareholder’s equity. It is also known as the return on net assets.

Return On Equity (ROE) = Annual Net Income/Shareholders Equity 

Here, the shareholder’s equity represents the difference between the assets and liabilities of a company, also known as the book value used in calculating the price-to-book (P/B) ratio. Hence, the usage of ROE and P/B ratio together can provide a more comprehensive and in-depth view of a company’s performance and true valuation. 

• Return on equity (ROE) refers to the return generated on each unit of a company’s shareholder’s equity. 
• ROE can be used along with the P/B ratio to get an in-depth analysis of a stock. 
• ROE and P/B ratio values are both calculated using the shareholder’s equity or book value of a company.

Key Takeaways (P/B) Ratio

At the end of this blog, we can conclude the following:

• The price-to-book (P/B) ratio is a vital ratio for identifying undervalued stocks that have high growth potential. 
• The P/B ratio value is calculated by dividing the market value by the book value of a company. 
• It can also be calculated by dividing the company’s current market price/book value per share. 
• The ratios have various applications, such as valuation, peer-to-peer comparison and more. 
• Company analysis based solely on the P/B ratio can be misleading; therefore, it should be used in conjunction with other ratios, such as price-to-earnings ratios and return on equity (ROE).

Frequently Asked Questions (P/B) Ratio

1. What is the price-to-book (P/B) ratio?

P/B Ratio meaning: The price-to-book (P/B) ratio is primarily used by long-term or value investors. It represents the relationship between the market value and book value of a company. It is calculated by dividing the market value or market cap by a company’s book value. The resulting value of the P/B ratio is used in company valuation and peer-to-peer comparison. 

2. What is a good P/B ratio?

Usually, a P/B ratio value of lower than 1.0 is considered good by investors. Stocks with a P/B value of 1 or lower indicate that they are undervalued and have growth prospects. 

3. What do undervalued stocks mean?

Undervalued stocks are shares of companies that are valued lower on the stock market than their actual value. It means that an undervalued share is available at a lower price than the value it should actually be trading on the market. 

4. Where can I find the price-to-book (P/B) ratio of a company?

You can look for the price-to-book (P/B) ratio value of a company on various stock screeners and stock trading apps & websites. You can also download and use the Univest mobile application to search for P/B ratios of different listed companies.

5. What does a P/B ratio value of 1 mean in the share market?

A P/B ratio value of 1 means that the book value and market value of a stock are equal. It indicates a neutral view of investors for a share relative to its book value. 

6. Is the shareholder’s equity and book value of a company the same?

Yes, the shareholder’s equity or just equity, is the same as a company’s book value. 

Book Value = Assets – Liabilities (shareholder’s equity)

7. What is the market value of a company?

The market value or market capitalisation of a company refers to the current value of a company based on its share price and number of outstanding shares. Market value is calculated by multiplying the current market prices by the total outstanding shares of a company. 

    Market cap or Market Value  = current market value per share X total outstanding    shares 

8. What is ROE, and how is it calculated?

The Return on Equity (ROE) refers to the financial ratio investors use to assess the returns a company can provide on their invested capital. The ROE value represents the relationship between the company’s annual income and the shareholder’s equity or book value. 

   Return on Equity (ROE) = Net Income / Shareholder’s Equity