Ratio Analysis plays an important role to analyze a company’s financial position, liquidity, profitability, risk, solvency, efficiency and operations. It is crucial for investment decisions and helps in knowing the company has been performing for some time. Despite it’s not being a fool proof method, it is a good way to run a fast check on a company’s health. There are numerous financial ratios which help an investor to know about the current status of the company. One of the most important ratios in the financial world is Price to Book ratio.
Price to Book value ratio is used to evaluate whether the stock of a company is overvalued or undervalued by comparing the price of all outstanding shares with the net assets of the company.
Price to Book ratio is calculated by dividing a company’s stock price by its book value per share. It is a great valuation metric. It is calculated by dividing a company’s stock price by its book value per share.
Price to Book value = Market price per share/ Book value per share
OR
Price to Book Value = Market Capitalization/ Book Value of equity
Let’s understand the Book value first,
Book Value = It is the total value that would be left over according to the company’s balance sheet, if it goes bankrupt immediately. It means that the amount shareholders would theoretically receive, if the company liquidates all its assets after paying off all its liabilities.
Book Value = Assets- liabilities
Book value is calculated by total assets minus total liabilities.
Let’s try to understand with the example, a company A has a book value of Rs 100 million on its balance sheet, and it has 10 million outstanding shares. Afterwards, dividing these two numbers gives us a book value of Rs 10 per share. Further, if the current share price is of Rs 20, then this translates to a price to book value multiple of 2.
Significance of P/B value ratio:
By comparing the book value of equity to its market price, investors get an idea of whether a company is under price or overpriced. Apart from looking into other financial ratios, it’s always better to compare P/B ratios within industries.
A P/B ratio less than one indicates that the stock is trading less than its book value, or it is undervalued. It is a good buy for the value investor. Conversely, If the P/B ratio is greater than one, then it means that it is overvalued or relatively expensive. It is a good buy for a growth investor. Depending upon your style, one can choose the stocks.
*Disclaimer: investment in securities market are subject to market risks, read all the related documents carefully before investing