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<\/a><\/figure><\/div>\n\n\n\nBook value is not usually explicitly referred to in a company\u2019s financial statements, but is commonly known as another term for shareholders\u2019 equity, which is referenced in a financial statement (the balance sheet).<\/p>\n\n\n\n
The formula for the P\/B ratio is the following:<\/h2>\n\n\n\n
Price to Book Value (P\/B)<\/strong><\/p>\n\n\n\n = Price \/ Book Value The reason why we substitute Market Capitalization for Price in Price to Book Value is because both Book Value and Market Capitalization compare the total value<\/strong> for a company, rather than its per-share value<\/strong>.<\/p>\n\n\n\n Price-based relative valuation ratios such as P\/B and P\/E need to be calculated on an apples-to-apples basis, where the numerator (price) and denominator (book value or earnings) need to both be on a total value or per-share value basis.<\/p>\n\n\n\n To calculate the Price to Book Value (P\/B) Ratio on a per-share basis, the formula is:<\/p>\n\n\n\n\n\n\n\n Price to Book Value (P\/B)<\/strong><\/p>\n\n\n\n = Price Per Share \/ Book Value Per Share You can see that calculating a company\u2019s Book Value Per Share, or BVPS<\/a>, allows us to use the company\u2019s stock price in the P\/B ratio, rather than having to calculate Market Capitalization (which is Stock Price multiplied by Shares Outstanding).<\/p>\n\n\n\n The P\/B is a common ratio referred to in value investing strategies<\/a>, especially because its usage was first popularized by \u201cthe godfather of value investing\u201d Benjamin Graham in his bestselling book The Intelligent Investor<\/em>.<\/p>\n\n\n\n Ben Graham was famously Warren Buffett\u2019s teacher at Columbia University, and had a huge influence in the early parts of Warren Buffett\u2019s career.<\/p>\n\n\n\n Price to Book Value, like Price to Earnings, is a ratio to tell investors how cheap or expensive a stock is compared to a specific financial metric\u2014in this case Book Value. In general, higher Price to Book Value stocks are considered more expensive, though this can vary greatly depending on a company\u2019s profitability and expected future growth.<\/p>\n\n\n\n Ratios like the P\/B are especially useful in allowing investors to compare one company\u2019s price in the stock market to another, regardless of how big or small those companies are.<\/p>\n\n\n\n Since the stock market has such a wide range of sizes, from companies that are $10 million in market capitalization to companies that are over $1 trillion, Price to Book Value is a simple, quick way to compare a company\u2019s valuation (cheapness or expensiveness) relative to another\u2019s.<\/p>\n\n\n\n P\/B became an extremely popular formula in Buffett\u2019s rise to popularity, because Buffett would frequently credit Ben Graham\u2019s ideas as behind the foundation of his strategy.<\/p>\n\n\n\n Investors who read Graham\u2019s The Intelligent Investor<\/em> grew really attached to the formulas in the book, such as the Graham number<\/a>, which used the P\/B ratio to assign a value to a stock.<\/p>\n\n\n\n Graham preferred low P\/B stocks, especially those trading less than 1, because buying a stock with a Price to Book less than 1 is like getting $1 bills for less than $1. This strategy took on a newer form called \u201cnet net investing\u201d, in which investors simply buy companies trading for less than the Net Asset Value, a very similar concept to buying stocks with a P\/B less than 1.<\/p>\n\n\n\n Investors really like the P\/B ratio because of the simplicity behind it, and its empirical nature.<\/p>\n\n\n\n There is no debate on what a company\u2019s Book Value is, it is right there on the balance sheet. So, there\u2019s also no debate on its P\/B, and it can be used in a highly scientific fashion.<\/p>\n\n\n\n Studies came out in the subsequent decades to Graham\u2019s bestseller, such as those by Fama and French<\/a> and James O\u2019Shaughnessy<\/a>, which showed backtests where investors could\u2019ve outperformed the market by simply buying many low P\/B stocks, selling the portfolio, and then re-buying many low P\/B stocks on a frequent basis.<\/p>\n\n\n\n Like I mentioned earlier, a company\u2019s profitability and future growth has a huge bearing on its P\/B ratio and can sometimes make using the P\/B a poor way to compare valuations, especially if a company is able to earn high returns on its equity (or ROE<\/a>).<\/p>\n\n\n\n Because Price to Book Value looks at a company\u2019s (shareholders\u2019 equity), it is a formula that is highly influenced by that company\u2019s assets.<\/p>\n\n\n\n And not all assets are created equally.<\/p>\n\n\n\n Some assets create much higher returns than others (are more efficient), and some assets are valued differently on balance sheets because of accounting rules.<\/p>\n\n\n\n 1– Differences in Efficiency<\/strong><\/p>\n\n\n\n Take the difference between a highly capital intensive mining company, and a high margin consumer products company.<\/p>\n\n\n\n For a mining company, most have to buy expensive equipment (long term asset<\/strong>) which allows them to dig holes in the ground on tough terrain. This equipment can be expensive, and if it is just one piece of the mining company\u2019s required investments and expenses, can result in a relatively low level of profits compared to the capital needed.<\/p>\n\n\n\n On the flip side, if a consumer products company becomes very popular with consumers (such as through word of mouth), it may only need a small number of manufacturing plants (long term assets<\/strong>) in order to produce high volumes of its products and thus relatively high levels of profits.<\/p>\n\n\n\n The consumer products company will probably have a higher Return on Equity (ROE) than the mining company if these factors are in place; therefore it is likely to also have a higher Price to Book Value too.<\/p>\n\n\n\n 2– Differences in Asset Accounting<\/strong><\/p>\n\n\n\n Due to accounting rules, assets are required to be recorded at cost<\/strong> on balance sheets. This remains true even if the asset is becoming more valuable over time.<\/p>\n\n\n\n While long term assets like equipment may lose value over time, other long term assets like real estate are likely to increase in value over time, but both will be recorded at cost on the balance sheet and then depreciated over time.<\/p>\n\n\n\n The way that the asset value of brands is calculated can also vary greatly depending on a company\u2019s situation; brands that were acquired through M&A show up as an asset on the balance sheet, while those generated internally do not.<\/p>\n\n\n\n These differences and more can skew a company\u2019s asset values, which skews their book value, which makes a P\/B ratio potentially deceiving to the investor.<\/p>\n\n\n\n Like with the P\/E ratio<\/a>, companies that have lower growth prospects or have matured in their company life cycle<\/a> will usually trade at lower P\/B ratios. They can also trade at lower P\/B ratios because they are much less capital efficient (lower ROE\u2019s) than the average.<\/p>\n\n\n\n Investors tend to buy companies with better growth prospects, whether tangible or imagined. So if a company has had a poor growth track record, or a perceived dim future, it will tend to trade lower.<\/p>\n\n\n\n Lower sentiment around a stock will usually reduce its P\/B ratio, but the extent of this factor can vary greatly due to the profitability of the company and its industry too.<\/p>\n\n\n\n When you look at a company\u2019s P\/B ratio, make sure you are comparing it with its peers<\/strong> in order to get a better picture on whether the low P\/B ratio indicates a stock that\u2019s truly a better deal. Keep in mind that even this approach can be flawed<\/strong> too though, especially if an entire industry has fallen out of favor with the market.<\/p>\n\n\n\n Really quickly I want to show the exact relationship between P\/B and ROE, because when I learned this myself it really explained to me why high ROE usually means high P\/B.<\/p>\n\n\n\n Say we have two companies trading at a Price to Earnings (P\/E) ratio of 20.<\/p>\n\n\n\n Let\u2019s say that both companies are trading at $100, which means their earnings are $5.00 per share ($100 divided by 20 is equal to $5). Now let\u2019s say that company A has a Return on Equity of 40% while company B has a Return on Equity of 10%.<\/p>\n\n\n\n
= Market Capitalization \/ Shareholders\u2019 Equity
= Market Capitalization \/ (Total Assets \u2013 Total Liabilities)<\/p>\n\n\n\n
= Stock Price \/ Book Value Per Share
= Stock Price \/ [(Shareholders\u2019 Equity \/ Shares Outstanding)]<\/p>\n\n\n\nPrice to Book Value Meaning<\/h2>\n\n\n\n
Price to Book Value Usage in Value Investing<\/h2>\n\n\n\n
Why Some Companies Have High P\/B Ratios<\/h2>\n\n\n\n
Why Some Companies Have Low P\/B Ratios<\/h2>\n\n\n\n
The Math Behind Why ROE will Always Affect P\/B<\/h2>\n\n\n\n