Price-to-Book Ratio

Definition

The price-to-book ratio (P/B ratio) is a financial ratio that compares a company's market value to its book value. It is calculated by dividing the company's stock price per share by its book value per share. This ratio is used to evaluate the valuation of a company's stock and is an important metric in both market value ratios and multiple approaches to stock valuation.

5 Must Know Facts For Your Next Test

1. The price-to-book ratio is a useful metric for comparing the valuation of companies within the same industry or sector.
2. A low P/B ratio (below 1) may indicate that a stock is undervalued, while a high P/B ratio (above 1) may suggest that a stock is overvalued.
3. The P/B ratio is particularly relevant for capital-intensive industries, such as manufacturing and utilities, where a company's assets play a more significant role in its valuation.
4. A high P/B ratio can also indicate that a company has significant intangible assets, such as brand value or intellectual property, which are not fully captured on the balance sheet.
5. The P/B ratio is one of the multiple approaches used in stock valuation, along with other metrics like price-to-earnings (P/E) ratio and dividend discount model.

Review Questions

• Explain how the price-to-book ratio is calculated and its significance in evaluating a company's valuation.
  • The price-to-book ratio is calculated by dividing a company's stock price per share by its book value per share. This ratio provides insight into how the market values a company's assets and liabilities compared to their carrying value on the balance sheet. A low P/B ratio (below 1) may indicate that the stock is undervalued, while a high P/B ratio (above 1) may suggest that the stock is overvalued. The P/B ratio is particularly useful for evaluating companies in capital-intensive industries, where the value of tangible assets plays a more significant role in the overall valuation.
• Discuss the relationship between the price-to-book ratio and the intrinsic value of a company.
  • The price-to-book ratio is used as an estimate of a company's intrinsic value. A low P/B ratio (below 1) may suggest that the stock is trading at a discount to its intrinsic value, as the market value is lower than the company's net worth or equity. Conversely, a high P/B ratio (above 1) may indicate that the stock is trading at a premium to its intrinsic value, as the market value exceeds the company's book value. Investors can use the P/B ratio, along with other valuation metrics, to determine whether a stock is undervalued or overvalued compared to its true, underlying worth.
• Analyze the role of the price-to-book ratio in the context of market value ratios and multiple approaches to stock valuation.
  • The price-to-book ratio is a key market value ratio that provides insights into a company's valuation. It is one of the multiple approaches used in stock valuation, along with other metrics like the price-to-earnings (P/E) ratio and dividend discount model. The P/B ratio is particularly useful for comparing the valuations of companies within the same industry or sector, as it helps identify undervalued or overvalued stocks. Additionally, the P/B ratio can be used to estimate a company's intrinsic value, which is the true, underlying worth of the business. By considering the P/B ratio in conjunction with other valuation methods, investors can make more informed decisions about the fair value of a company's stock.

Related terms

Book Value: The book value of a company is the value of its assets minus its liabilities, as reported on the company's balance sheet. It represents the net worth or equity of the company.

Market Value: The market value of a company is the total value of its outstanding shares, as determined by the market price of the stock. It represents what investors are willing to pay for the company's stock.

Intrinsic Value: The intrinsic value of a company is its true, underlying value based on an evaluation of its assets, liabilities, growth potential, and other fundamental factors. The price-to-book ratio is used to estimate a company's intrinsic value.