Price to book value ratio formula and examples

The price to book value ratio formula (P/B ratio) is used to compare a company’s market capitalization to its book value. This price to book value is one of the important ratios used for relative valuations. The ratio is most applicable for identifying stock opportunities in financial companies, most especially banks. It is commonly used to compare banks because the majority of assets and liabilities of banks are constantly valued at market values. Therefore, a price to book value ratio analysis is an essential part of an overall value investing approach.

The P/B ratio is a type of market prospect ratio and is usually used alongside other business valuation tools like PE (price to earnings) ratio, PCF (price to cash flow) ratio, PEG ratio (price to earnings/ earnings growth rate), and EV/EBITDA (Enterprise Value (EV) to Earnings Before Interest, Taxes, Depreciation & Amortization). The price-to-book ratio (P/B ratio) can be calculated by dividing the company’s stock price per share by its book value per share (BVPS). This book value per share can be negative or positive. More so, the book value of an asset is equal to its carrying value on the balance sheet, and companies usually calculate it by netting the asset against its accumulated depreciation.

This article will discuss the price to book value ratio meaning, how it can be calculated, interpretations, and its importance.

The book value of equity is the value of a company’s assets expressed on the balance sheet which is expressed as the difference between the book value of assets and the book value of liabilities. Investors make use of the price-to-book value to assess whether a stock is valued properly. The stock price to book value ratio means the stock price is trading in line with the book value of the company.

Therefore, from a P/B standpoint, companies with a high price to book value ratio could mean the stock price is overvalued, whereas companies with a lower price book ratio could mean the stock is undervalued. However, price to book ratios doesn’t directly provide any information on the ability of the firm to generate profits or cash for shareholders.

Furthermore, the price to book ratio also gives insights into whether an investor is paying too much for what would be left if the company went bankrupt suddenly. For firms in distress, the book value is usually calculated without the intangible assets that would have no resale value. In such cases, the price to book ratio should also be calculated on a diluted basis. This is because stock options may be well vested on the sale of the company or change of management control or firing of management.

The measure of the price-to-book ratio by industry varies and this is why the ratio should be compared with companies within the same sector. For some industries, the ratio is higher, and in others, it is lower. Industries that need more infrastructure capital (for each dollar of profit) will usually trade at price book ratios that are much lower. Hence, it is essential to compare the P/B ratio to companies with a similar makeup of assets and liabilities.

What is a good price to book value ratio?

Pinpointing a specific numeric value as a good price to book value ratio is quite difficult when determining if a stock is undervalued and a good investment. One of the reasons is that share price to book value ratio analysis can vary by industry and a good price-book ratio for one industry may be a poor ratio for another industry.

Therefore, it is important to identify some general parameters or a range for the price/book ratio and then consider several other valuation measures and factors that accurately interpret the P/B value better, forecasting the potential growth of the company. Companies with high growth will often show P/B ratios above 1.0, whereas companies facing severe distress will occasionally show ratios below 1.0.

In order words, what will be considered a good price to book ratio will depend on the industry in question and the overall state of valuations in the market. Take, for instance, the average price-to-book ratio of technology companies was on a steady rise between 2010 and 2020 listed on the Nasdaq stock exchange, roughly tripling during that period. Now, an investor assessing the price to book ratio of one of the technology companies may choose to accept a higher average P/B ratio, as compared to an investor looking at a company in a more traditional industry in which a low price to book value ratio seems to be the usual.

For decades, the P/B ratio has been favored by value investors and is extensively used by market analysts. Traditionally, value investors consider any value under 1.0 as a good price to book value ratio, indicating a potentially undervalued stock. However, they usually still consider stocks with a price to book value under 3.0 as their benchmark.

Price to book value ratio formula and examples
Price to book value chart

Price to book value ratio formula

There are two price to book value formulas used in calculating the price/book ratio which still give the same results.

Price to book value ratio formula
Price to book value ratio formula

The formula for price to book value ratio is expressed as:

Price to Book value ratio (P/B) = Market Capitalization / Book Value of Equity

Alternatively,

Price to Book value ratio (P/B) = Current share Price / Book Value Per Share

The price/book ratio is calculated by dividing the market capitalization of a company by its book value of equity as of the latest reporting period. In the equation (Market Capitalization / Book Value of Equity), the market capitalization is expressed as (Latest closing share price × Total diluted shares outstanding) while the book value of equity is calculated as total assets minus total liabilities (total assets – total liabilities).

Alternatively, the P/B ratio can also be calculated by dividing the latest closing (current) share price of the company by its most recent book value per share. In the equation (Current share Price / Book Value Per Share), the company’s current market share price is obtained by simply looking at the share price quote in the market while the book value per share is calculated as (total assets – total liabilities) divided by the number of shares outstanding. This equation can be useful when you’re conducting a thorough analysis of a stock.

How to calculate price to book value ratio using the PB ratio formula

The price to book value ratio calculation can be done in two ways, but the result should be the same. The first method of calculating the price book ratio is to divide the company’s market capitalization by the company’s total book value from its balance sheet.

The second method is using per-share values, which is to divide the company’s current share price by the book value per share. Whereby the book value per share is calculated as the company’s book value divided by the number of outstanding shares. This method is also expressed as the market-to-book ratio and the price-to-equity ratio (which should not be confused with the price-to-earnings ratio).

This technically means that the price to book value ratio can be calculated either including or excluding intangible assets and goodwill. However, when intangible assets and goodwill are excluded, the ratio is usually specified as price to tangible book value or price to tangible book.

In order to calculate the price to book value ratio, the following input is needed:

  1. The market price of the stock
  2. Market capitalization which is expressed as current share price × total diluted shares outstanding
  3. The total amount of assets from the balance sheet
  4. The total amount of liabilities from the balance sheet
  5. Total number of outstanding shares
  6. Book value which equals a company’s total assets minus its liabilities
  7. Book value per share is the book value by the number of shares outstanding.

Price to book value ratio calculation examples

Here are some examples of how to calculate price to book value ratio:

Example 1

Using the pieces of information given on company XYZ in the table below, calculate the price/book ratio.

AssetsLiabilitiesOutstanding sharesStock price
$100 million$75 million10 million$5 per share
Price to book value ratio calculation example 1

Solution

From the information given, we will use the Price to book value ratio formula:

Current share Price / Book Value Per Share

Since we have the share price as $5, let’s calculate the book value per share:

Using the formula for book value:

(Total assets – Total liabilities) = $100 million assets – $75 million liabilities

i.e Book value =$25 million

Calculating the book value per share:

(Book value / number of shares outstanding) = ($25 million book value / 10 million outstanding shares)

i.e The book value per share = $2.50

Now, let’s input the solved values into the P/B ratio equation

Current share price (stock price per share)= $5

Book Value Per Share=$2.50

i.e Current share Price / Book Value Per Share = ($5/$2.50)= 2

This means that the stock of company XYZ is trading at 2 times its book value. Nevertheless, the justification of the valuation would depend on how the P/B ratio compares to its value in the past years and the ratio of other companies within the same industry.

Alternatively,

We can use the other formula for price to book value ratio (Market Capitalization / Book Value of Equity) to calculate the P/B ratio of company XYZ.

Market Capitalization= (current share price × total diluted shares outstanding)= $5 ×10 million

Book Value of Equity= (total assets – total liabilities)=$100 million assets – $75 million liabilities

Market Capitalization / Book Value of Equity= ($5 ×10 million) / ($100 million – $75 million)

i.e 50 million / 25 million = 2

This gives us the same value of 2 as the first solved solution, which tells us that the stock of company XYZ is trading at 2 times its book value.

Example 2

Using the pieces of information given on a software company named MICKEY in the table below, calculate the price to book value ratio.

Total AssetsTotal liabilitiesOutstanding sharesCurrent share price
$3 billion$2 billion100 million$15
Price to book value ratio calculation example 2

Solution

From the information given, we will use the Price to book value ratio formula:

Current share price / Book value per share

Since we already have the current share price of $15

Let’s calculate the book value per share using the formula for book value:

(Total assets – Total liabilities) = $3 billion assets – $2 billion liabilities

i.e Book value =$1 billion

Calculating the book value per share:

(Book value / number of shares outstanding) = ($1 billion book value / 100 million outstanding shares)

i.e The book value per share = $10

Now, let’s input the solved values into the Price to book value ratio equation

Current share price= $15

Book Value Per Share=$10

i.e Current share price / Book value per share = ($15/$10)= 1.5

This means that the stock of the software company (MICKEY) is trading at 1.5 times its book value.

Example 3

With the given information in the table below, what will be the price-to-book value ratio of the company?

Total AssetsTotal liabilitiesTotal Diluted Shares OutstandingLatest closing share price
$5 billion$4 billion100 million$25.00
Table for price to book value ratio calculation example 3

Solution

We can use the Price to book value ratio formula: Market Capitalization / Book Value of Equity

Using the information given,

Latest closing share price= $25.00

Total diluted shares outstanding= 100 million

We can calculate the market capitalization (numerator)

Market Capitalization= Current share price × Total diluted shares outstanding

= $25.00 × 100 million = $2.5 billion

i.e Market Capitalization= $2.5 billion

Having gotten the numerator, let’s calculate the denominator (Book value of equity)

Book Value of Equity (BVE)= (total assets – total liabilities)

=$5 billion assets – $4 billion liabilities

i.e Book Value of Equity (BVE)= $1 billion

Market Capitalization / Book Value of Equity= ($2.5 billion/ $1 billion)= 2.5

This means the P/B Ratio of the company is 2.5x the book value

Alternatively,

We can use the other formula for price to book value ratio (Current share price / Book value per share) to calculate the P/B ratio of the company.

Since we already have the current share price of $25.00

Let’s calculate the book value per share using the formula:

(Book value/number of shares outstanding)

= ($1 billion book value / 100 million outstanding shares)

i.e The book value per share = $10

Now, let’s input the solved values into the Price to book value ratio equation

Current share price= $25

Book Value Per Share=$10

i.e Current share price / Book value per share = ($25/$10)= 2.5

This means that the stock of the company is trading at 2.5x its book value. Conclusively, whether the company’s stock is undervalued, fairly valued, or overvalued will be based on how the company’s ratios compare with the industry average multiples.

P/B ratio interpretation

The market price to book value ratio interpretation varies by industry. The interpretation of price to book value ratio would reflect the value that market participants attach to a company’s equity in relation to the book value of its equity. The market value of a stock is a metric that reflects a company’s future cash flows while the book value of equity is an accounting measure that reflects past issuances of equity, which is reduced by share buybacks and dividends, and supplemented by any profits or losses.

The value remaining when a company liquidated all its assets and pays all its debt would be the company’s book value. Therefore, the interpretation of a price to book value ratio as high or low can indicate whether you’re paying too much for what would remain if the company went bankrupt suddenly. It gives a valuable reality check for investors seeking growth at a reasonable price. This ratio is often looked at together with return on equity (ROE), a reliable growth indicator.

However, when there is a large difference between the price-to-book ratio and ROE, this usually sends up a red flag for companies. This is because a combination of low ROE and high price-to-book value ratios is frequently seen in overvalued growth stocks. If the company has overvalued assets, investors might believe that the company’s asset value is overstated and would likely avoid the company’s shares. This is because there is a likelihood that the asset value of the company will face a downward correction by the market. Hence, leaving investors with negative returns.

For value investors, the price-to-book value ratio is a tried valuation tool for finding low-priced stocks that the market has neglected. Value investors usually look for opportunities where they believe the market has wrongly valued or priced a stock. A price to book value ratio under 1 could be a signal of an undervalued company that the market has misunderstood. So, a price to book value ratio less than 1 could mean the stock is undervalued. This means that the stock price is trading at a lower price relative to the value of the company’s assets.

Nevertheless, a lower P/B ratio could also be an indicator that something is fundamentally wrong with the company. It could mean that the company is earning a very poor (even negative) return on its assets (ROA). However, the upside to this is that for a company that has poor earnings performance, there is a chance that new management or new business conditions will trigger a turnaround in prospects and give strong positive returns. Even without that happening, a company that is trading less than its book value can be broken up for its asset value, and shareholders could earn a profit.

Apart from interpreting a price to book value ratio as undervalued or overvalued, it could be negative. A negative price to book value ratio may arise when the company has a negative book value. This means that a company has more total liabilities than total assets and numerically, owes more than it owns. However, a company having a negative book value doesn’t automatically make the company a bad investment or a company with a weak balance sheet.

Is high price to book ratio good?

There is really no ideal price to book value ratios because one can’t use the P/B alone to buy a stock safely. However, the rule of thumb is that a lower P/B ratio is a better deal if all parameters are the same. When comparing the price to book value of the target stock with its peers, the higher it is compared to its peer stocks, the riskier it is. This is why companies with the highest price to book value ratio are likely to be avoided by investors.

A P/B ratio that is greater than 1 indicates that the stock price is trading at a premium to the company’s book value. For instance, a company with a price-to-book value of 3, suggests that the company’s stock is trading at three times its book value. Hence, the stock price could be overvalued relative to its assets.

Higher price to book value ratios is predicated on the fact that investors expect management to create more value from a given set of assets. Therefore, the lower a company’s price-book ratio is, the better a value it is generally. This means that buying a company’s stock for less than its book value can create a margin of safety for value investors.

Importance

The importance of the price to book value ratio as one of the most widely-used financial ratios is that it compares a company’s market price to its book value. Thus, showing the value given by the market for each dollar of the company’s net worth.

This financial ratio is important because it can help investors understand whether the market price of a company seems reasonable when compared to its balance sheet. It is also frequently used to screen potential investment opportunities. For example, low price-to book value stocks indicate that the stock price is trading at a lower price relative to the value of the company’s assets.

The P/B ratio is useful to investors because the book value of equity provides a relatively stable and intuitive metric that they can easily compare to the market price. More so, this ratio can also be used for firms that have positive book values and negative earnings since negative earnings render price-to-earnings ratios useless.

Limitations of the price to book value ratio formula

One of the limitations of the P/B ratio is that it may not be comparable when accounting standards applied by firms vary especially for companies from different countries. Also, this ratio can be less useful for service and IT companies with little tangible assets on their balance sheets. Furthermore, the P/B ratio can be rendered useless for relative valuation when the book value becomes negative due to a long series of negative earnings.

Other potential problems in using the price to book value ratio formula could arise from the fact certain kinds of situations can affect the figure of the book value in the equation, such as recent write-offs, recent acquisitions, or share buybacks. Therefore, when searching for undervalued stocks, investors should consider multiple valuation measures to complement the price-to-book value ratio.

P/B ratio advantages and disadvantages

The price to book value ratio has its advantages and disadvantages. The major advantage of using the P/B ratio is that it helps investors understand whether the market price of a company seems reasonable when compared to its balance sheet. In other words, it is useful for screening potential investment opportunities.

The disadvantage of the price to book ratio is that it is only useful for evaluating certain types of businesses. This ratio may be unhelpfully high if a majority of a business’s assets are intangible as is the case with many technology companies. For instance, the software giant Microsoft trades for more than 10 times its book value. Conversely, the ratio can be useful for capital-intensive businesses like banks.

In addition, the P/B ratio analysis alone doesn’t tell us much. Therefore, in order to get a clearer picture of a company’s valuation, the P/B ratio should be used in combination with profitability metrics such as return on equity (ROE). Conclusively, in as much as the price to book can be a useful metric, it’s only part of the puzzle when it comes to evaluating which stocks are undervalued.

A video explaining the price to book value ratio formula, and calculation examples
Last Updated on July 19, 2022 by Nansel Nanzip Bongdap
Obotu Agape Oguche
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