What is the Price to Book Ratio?
The Price to Book ratio is used to compare a company’s current market price to its book value. This ratio is strongly preferred by conservative investors because it offers a more tangible valuation of a company than their earnings. While the market value of a company, also known as the company’s market cap, is determined by financial markets, the book value of a company is determined on a company’s balance sheet. Book value literally means the value of a company according to their books, i.e. their financial statements. A company’s book value is the total value of a company if they decided to liquidate their assets and pay all their liabilities back. In other words, the book value is equal to a company’s equity – or net asset value, the total assets less the total liabilities. Because of this, the P/B ratio gives investors a better idea of the amount of assets backing a company compared to other market multiple ratios.
- A favorite of value investors because the book value is a more tangible valuation of a company than their earnings.
- The P/B ratio differs from other market multiple ratios such as the P/E ratio and P/S ratio, in that the P/B ratio measures a company’s market value to its book value, while the P/E ratio only takes into account the stock price and earnings, and the P/S ratio only measures a company’s stock price relative to revenue.
- The P/B ratio, while useful, is not a comprehensive and conclusive valuation ratio, because it does not work well for companies with little assets, such as tech companies, and does not account for a company’s growth prospects, nor a company’s earnings
- It is hard to determine what a “good” P/B ratio is. A good P/B ratio for one industry may be a bad one for another. While P/B ratios under 1 are typically considered good investments, analysts and investors all have different criteria.
P/B Ratio Formula
The P/B ratio is calculated using the following formula:
P/B Ratio=Current Price Per Share/Book Value Per Share
- Current Price Per Share: The current price per share, is also known as the market price, market price per share, share price, or current stock price. This is the most recent price that a stock has traded at. It’s a very unique number, as it is always changing, and is completely at the mercy of market forces. The current price per share changes as investors buy or sell the stock, and changes constantly during the trading day. This is not a fixed price.
- Book Value Per Share: The Book Value Per Share takes a company’s common equity and divides it by its number of shares outstanding. This value essentially indicates a company’s net asset value (total assets-total liabilities) on a per-share basis.
How to Calculate the P/B Ratio Using the Balance Sheet and Income Statement
It is quite easy to calculate a company’s P/B ratio by using its balance sheet and income statement. Let us take a company with a lot of assets to its name such as AT&T (T).
Before digging into AT&T’s balance sheet, let’s see how much the stock is trading for right now.
Now that we know the price per share, let’s go through AT&T’s balance sheet and figure out its book value. This is AT&T’s balance sheet from the most recent quarter.
To figure out its book value, we simply take total assets – total liabilities to get the company’s share holder equity as it says on the balance sheet.
So $547,898 of assets minus $354,445 of liabilities is equal to $193,453 of equity – otherwise known as the company’s book value.
Next let’s take a look at AT&T’s income statement and find the amount of shares outstanding.
We can see that AT&T has 7,170 shares outstanding. Now we can calculate the book value per share.
Book Value Per Share=$193,453/7,170
Book Value Per Share=26.98
Now that we have AT&T’s price per share and their book value per share, we can calculate the P/B ratio.
AT&T’s P/B ratio of 1.07, for some investors would be considered just a tad bit too. However, because anything under 1 is considered undervalued, while others consider anything under than 3 attractive, this is quite a solid P/B ratio. This means that AT&T has the backing of tangible assets, and is trading at a fairly decent value.
What is a Good P/B Ratio?
As previously stated, a “good” P/B ratio under 1 is usually considered undervalued or “good,” however, many consider a P/B ratio under 3 as “good.” Like P/E or P/S, there’s not necessarily one right or wrong answer when deciding if a P/B ratio is “good” or “bad.” It is largely subjective, and dependent on how conservative an investor is. P/B ratio also largely depends on the industry in which a company operates. Again, companies with less assets may have deceptively high P/B ratios. Companies that are considered mature with lots of assets also could have P/B ratios that may look deceptively attractive, and really point out fundamental problems within the company.
Comparing P/B Ratios Between AT&T (T), JP Morgan (JPM), and Netflix (NFLX)
To put this in practice, let’s compare the P/B ratios of AT&T (T) to the P/B ratios of JP Morgan (JPM) and Netflix (NFLX). JP Morgan (JPM) is a big bank stock and mature company and will have lots of assets to its name, while Netflix (NFLX) is a streaming platform with little assets to its name, yet has seen robust returns over the past few years.
Look at the P/B ratios between the 3 companies. AT&T (T) and JP Morgan’s (JPM) P/B ratios really have not moved much over the last 3 years, despite all of the market volatility. They are also at a relatively similar value. Now look at Netflix’s (NFLX) P/B ratio. It has fluctuated along with the market’s moves, and is at a very high ratio of 22.13. But what does this really tell us? They are 3 different companies, in 3 different fields, and trade differently. While AT&T (T) and JP Morgan (JPM)’s P/B tells us that their stock is not trading at much of a higher multiple than its book value, Netflix’s (NFLX) stock is trading at over 22x its book value and is very sensitive to market movements. They also do not have a lot of assets backstopping their stock. But this really does not tell us much more outside of that. Again, growing companies with less assets may have deceptively high P/B ratios. Companies that are considered mature with lots of assets will have lower P/B ratios.
All of the following reasons might lead to some issues when interpreting the P/B ratio:
- Useless For Some Types of Companies The P/B ratio is useful for companies that have a lot of assets to their names. However, when evaluating tech companies that don’t necessarily have a lot of assets, this is not a useful ratio as they will have deceptively high P/B ratios.
- Different Accounting Practices: Ratios such as the P/B ratio are not good when comparing companies with different accounting practices- namely international companies. Although the P/B ratio is helpful when comparing companies in similar industries, with a lot of assets, there can be confusion when comparing companies from different countries. AT&T (T) and Mobile Telesystems (MBT) may both be telecom companies. However, one is American and the other Russian. They will surely have very different accounting practices, and different levels of transparency. The multiples may be easily misinterpreted as a result, with inconclusive comparisons.
- Subjective Interpretation While this ratio is more based on fundamentals than other market multiple ratios, it is still largely subjective. Different investors have different philosophies, and there is not one right or wrong answer when deciding if the P/B ratio is “good” or “bad”. Some may say a P/B of under 1 is attractive, some may say under 3 is attractive.
- Any Material Event Can Distort The Ratio Compared to other ratios, material events that a company can go through such as a recent acquisition, a recent write-off, or share buybacks, can greatly distort the book value of a company, and therefore, distort the P/B ratio.
- Does Not Tell The Full Story While the P/B ratio does a good job as a simple metric in deciding if a company is undervalued or overvalued based on the relationship of its stock price to its book value per share, this ratio does not account for a company’s growth prospects, nor does it account for a company’s earnings. The P/B ratio is a good, solid, conservative valuation of a company; however, investors should really proceed with caution if they plan on using this ratio exclusively to evaluate a company.
P/B vs. P/E
The first ratio we can compare the P/B ratio to is the P/E ratio, or the Price-to-Earnings ratio.
The P/E ratio is calculated using the following formula:
P/E Ratio=Current Price Per Share/Earnings Per Share
- Current Price Per Share: The most recent price that a stock has traded at.
- Earnings Per Share: Earnings per share, or EPS, is the value of earnings per a company’s outstanding shares. This is calculated by dividing a company’s net income or net earnings by their outstanding shares. EPS shows how much money a company makes per share of their stock.
While the P/E ratio is advantageous in that investors can value stocks based on current stock price movements, they do not tell investors about the fundamentals of a company like the P/B ratio does. Both are good ratios to be used collaboratively though, because they expose different aspects about a company. While neither is a good conclusive ratio, and should be used with other complementary ratios, when used together to analyze a company, they can tell investors a decent story about a company’s value and financial health from different angles.
P/B vs. P/S
The next ratio we can compare the P/B ratio to is the P/S ratio, or the Price-to-Sales ratio.
The P/S ratio is calculated using the following formula:
P/S Ratio=Current Price Per Share/Sales Per Share
- Current Price Per Share: This has already been defined as the most recent price that a stock has traded at.
- Sales Per Share: The amount of revenue a company makes per share. It’s calculated by dividing a company’s revenue by a company’s outstanding shares. Both the revenue and outstanding shares need to be from the same reporting period- either quarterly or annually.
While the P/S ratio is advantageous in that it’s still useful even if companies are operating at a loss, this ratio, compared to P/B and P/E, is more easily manipulated and misleading. While it’s a suitable replacement for the P/E ratio in the event that a company is net negative, the fact that the P/S ratio doesn’t take into account whether or not the company is profitable, really makes it almost worthless as a standalone ratio. The P/E ratio is simply not comprehensive. Depending on the true profitability of a company, sales could be worth a little or a lot. For example, a company could be making billions in sales, yet lose money on every transaction- but the P/S ratio won’t tell you this.
|P/B Ratio Current Price Per Share/Book Value Per Share||The best for conservative investors-offers a more tangible valuation of a company than their earningsBest ratio to give investors an idea of the amount of assets behind a stock.||Useless when evaluating companies with little assets such as tech companies. Can be difficult when comparing companies that adhere to different accounting standards- ie. international companies.|
|P/E Ratio Current Price Per Share/Earnings Per Share||Easy to calculate and readily available.Quick and easy benchmark for investors to value of a stock, and compare with competitors and indexes.||TTM is based on past data, Fwd is based on unreliable and possibly untrustworthy projections.Not comprehensive, and does not consider debt, cash flow, or negative earnings.|
|P/S Ratio (Current Price Per Share/Sales Per Share)||Quick and easy snapshot in comparing companies within the same industry. Can still use the ratio even if a company is not profitable||Does not account for company profitability. It’s a useful ratio if the P/E ratio can’t be calculated, but this does not make this an acceptable standalone ratio. Does not tell investors the true value of a company’s sales. A company can make billions in sales, yet lose money on every transaction – but the P/S ratio doesn’t tell you this.|
Drawbacks to Market Multiple Ratios
Market multiples are a good, simple snapshot of a company’s valuation. However, there are several serious drawbacks to consider before putting too much stock and emphasis into these ratios.
- Difficult to Compare Companies in Different Sectors: These market multiple ratios are only truly useful when comparing companies within the same industry. Different companies in different industries have different growth prospects, different financial statements, and different revenue streams. What is the point in comparing the P/B ratio between JP Morgan (JPM) and Netflix (NFLX) for example, when JP Morgan (JPM) is the largest bank in the US by asset size, and Netflix (NFLX) is a streaming company with very little assets? What is the point in comparing JP Morgan (JPM) and Netflix’s (NFLX) P/S ratio, for example, when one company makes their money off of interest payments and the other company makes their money off of streaming subscriptions and licensing?
- Overly Simplifies Complex Information: Making these ratios so simple can be advantageous since it gives investors a quick snapshot into a company’s valuation. However, the oversimplification has serious flaws. By simplifying complex information into a single ratio, other factors that can influence a company’s performance are effectively ignored and disregarded.
- Only Accounts for Past Data: With the exception of the Forward P/E ratio and PEG ratio, which are largely based on future projections, market multiple ratios consider past data. Market multiple ratios only consider a company’s finances from the past and from a certain point in time. They also fail to include a company’s growth prospects or future business operations.
- Not Adjusted for Different Accounting Practices: This is especially relevant for the P/B ratio. These ratios, while mostly reliable when comparing companies from a similar sector, are not reliable when comparing companies with different accounting practices. Just look at the aforementioned AT&T (T) vs. Mobile Telesystems (MBT) example. Despite operating in the same industry, their P/B ratios were so off from each other, likely because they operate in different countries and have different accounting practices. These ratios may be easily misinterpreted as a result, with inconclusive comparisons.