What is the Price-to-Book Ratio (P/B)?
The Price-to-Book Ratio (P/B Ratio) measures the market capitalization of a company relative to its book value of equity. Widely used among the value investing crowd, the P/B ratio can be used to identify undervalued stocks in the market.
- How can the price-to-book (P/B) ratio be calculated?
- What is considered to be an “attractive” P/B ratio for investors?
- For which type of companies is using the P/B ratio recommended?
- What are some of the limitations of the P/B ratio?
In This Article
Price-to-Book Ratio (P/B) Definition
- Market Capitalization (Price): Calculated as the current share price multiplied by the total number of diluted shares outstanding
- Book Value (BV): The book value is the net difference between the carrying asset value on the balance sheet less the company’s total liabilities
In short, the market capitalization represents the pricing of a company’s equity according to the market (i.e. what investors currently believe the company to be worth).
The book value, on the other hand, reflects the value of the assets that a company’s shareholders would receive if the company were hypothetically liquidated.
Since the book value of equity is a levered metric (post-debt), the equity value is used as the point of comparison, rather than the enterprise value, to avoid a mismatch in the represented capital provider(s).
For the most part, any financially-sound company should expect its market value to be greater than its book value since equities are priced in the open market based on the forward-looking anticipated growth of the company.
P/B Ratio Formula
The price-to-book ratio (P/B) is calculated by dividing a company’s market capitalization by its book value of equity as of the latest reporting period.
Alternatively, the P/B ratio can be calculated by dividing the latest closing share price of the company by its most recent book value per share.
Interpreting the P/B Ratio
The norm for the P/B varies by industry, but a P/B ratio under 1.0x tends to be viewed favorably and as a potential indication that the company’s shares are currently undervalued.
The P/B ratio is generally more accurate for mature companies, like the P/E ratio, and is especially accurate for those that are asset-heavy (e.g. manufacturing, industrials).
In addition, the P/B ratio is typically avoided for companies comprised mostly of intangible assets (e.g. software companies).
In reality, very rarely is a company’s book value of equity lower than its market value of equity.
If the market valuation of a company is less than its book value of equity, that means the market does not believe the company is worth the value on its accounting books.
Price to Book Value (P/B) Ratio Commentary Slide (Source: WSP Trading Comps Course)
Limitations of the P/B Ratio
From a different perspective, underperformance can lead to lower P/B ratios, as the market value (i.e. the numerator) should rightfully decrease.
A sub-1.0x P/B ratio should NOT be immediately interpreted as a sign that the company is undervalued (and is an opportunistic investment).
Instead, a low P/B ratio can indicate problems with the company that could lead to value deterioration in the coming years (i.e. a “red flag”).
Companies with P/B ratios far exceeding 1.0x could be a function of recent positive performance and a more optimistic outlook on the company’s future outlook by investors.
While P/B ratios on the lower end can suggest a company is undervalued and P/B ratios on the higher end can mean the company is overvalued — a closer examination is still required before any investment decision can be made.
Excel File Download
Now, we’re ready to move on to an example calculation of the P/E ratio. To access the Excel file, fill out the form linked below.
Price-to-Book Ratio (P/B) Example Calculation
For our example exercise calculating the P/B ratio, we’ll be going through the steps for the two approaches we mentioned earlier.
The shared assumptions are listed below:
- Latest Closing Share Price: $25.00
- Total Diluted Shares Outstanding: 100mm
With those two provided metrics, we can calculate the market capitalization as $2.5bn
- Market Capitalization = Latest Closing Share Price × Total Diluted Shares Outstanding
- Market Capitalization = $25.00 × 100mm = $2.5bn
Now that the calculation for the numerator is done, we can now move to the denominator.
The assumptions for the book value of equity can be found below:
- Assets = $5bn
- Liabilities = $4bn
Upon subtracting Liabilities from Assets, we can calculate the book value of equity (BVE).
- Book Value of Equity (BVE) = Assets – Liabilities
- BVE = $5bn – $4bn = $1bn
To wrap up our price-to-book ratio (P/B) calculation under the first approach, we can divide the market capitalization by the book value of equity (BVE).
- P/B Ratio = Market Capitalization ÷ Book Value of Equity
- P/B Ratio = $2.5bn ÷ $1bn = 2.5x
Next, we’ll calculate the P/B ratio using the share price approach.
Since we already have the latest closing share price, the only remaining step is to adjust the book value of equity (BVE) to a per share basis.
- Book Value of Equity Per Share = Book Value of Equity ÷ Total Diluted Shares Outstanding
- Book Value of Equity Per Share = $1bn ÷ $100mm = $10.00
In the final step, we divide the current share price by the BVE per share.
- P/B Ratio = Latest Closing Share Price ÷ Book Value Per Share
- P/B Ratio = $25.00 ÷ $10.00 = 2.5x
Just like the first approach in which we divided the market capitalization by the book value of equity, we get 2.5x as the P/B ratio.
In conclusion, whether the company is undervalued, fairly valued, or overvalued will depend on how the company’s ratios compare with the industry average multiples, as well as the fundamentals of the company.
To reiterate from earlier, the P/B ratio is a screening tool for finding potentially undervalued stocks, but should always be supplemented with in-depth analyses of the underlying value drivers.