what the price to book p b ratio can tell you
the p b ratio reflects the value that market participants attach to a company s equity relative to the book value of its equity many investors use the p b ratio to find undervalued stocks by purchasing an undervalued stock they hope to be rewarded when the market realizes the stock is undervalued and returns its price to where it should be according to the investor s analysis some investors believe that the p b ratio is a forward looking metric that reflects a company s future cash flows however when you look at the information used to calculate the p b ratio the factors used are the price investors are willing to pay currently the number of shares issued by a company and values from a balance sheet that reflect data from the past thus the ratio isn t forward looking and doesn t predict or indicate future cash flows the p b ratio also provides a valuable reality check for investors seeking growth at a reasonable price it is often evaluated with return on equity roe a reliable growth indicator large discrepancies between the p b ratio and roe often raise a red flag for investors overvalued growth stocks frequently show a combination of low roe and high p b ratios properly valued stocks have roe and p b ratios that grow somewhat similarly because stocks that generate higher returns tend to attract investors and increase demand thus increasing the stock s market price a high p b ratio suggests a stock could be overvalued while a lower p b ratio could mean the stock is undervalued as with most ratios the p b ratio varies by industry a company should be compared with similarly structured companies in similar industries otherwise the comparison results could be misleading it is difficult to pinpoint a specific numeric value of a good price to book p b ratio when determining if a stock is undervalued and therefore a good investment it s helpful to identify some general parameters or a range for p b value then consider various other factors and valuation measures that more accurately interpret the p b value and forecast a company s potential for growth the p b ratio has been favored by value investors for decades and is widely used by market analysts traditionally any value under 1 0 is considered desirable for value investors indicating an undervalued stock may have been identified however some value investors may often consider stocks with a less stringent p b value of less than 3 0 as their benchmark due to accounting procedures the market value of equity is typically higher than a security s book value resulting in a p b ratio above 1 0 during times of low earnings a company s p b ratio can dive below a value of 1 0 for example in most cases companies must expense research and development costs reducing book value because this includes the expenses on the balance sheet however these r d outlays can create unique production processes for a company or result in new patents that can bring royalty revenues while accounting principles favor a conservative approach in capitalizing costs market participants may raise the stock price because of such r d efforts resulting in wide differences between the market and book values of equity example of how to use the price to book p b ratioassume that a company has 100 million in assets on the balance sheet no intangibles and 75 million in liabilities therefore the book value of that company would be calculated as 25 million 100 million 75 million if there are 10 million shares outstanding each share would represent 2 50 of book value therefore if the share price is 5 the p b ratio would be 2 0 5 2 50 this illustrates that the market price is valued at twice its book value which may or may not indicate overvaluation this would depend on how p b ratios compare against other similarly sized companies in the same sector the price to book ratio may not be as useful when evaluating the stock of a company with fewer tangible assets on its balance sheets such as services firms and software development companies price to book p b ratio vs price to tangible book ratioclosely related to the p b ratio is the price to tangible book value ratio ptvb the latter is a valuation ratio expressing the price of a security compared to its hard or tangible book value as reported in the company s balance sheet the tangible book value number is equal to the company s total book value less than the value of any intangible assets intangible assets can be items such as patents intellectual property and goodwill this may be a more useful valuation measure when valuing something like a patent in different ways or if it is difficult to put a value on such an intangible asset in the first place limitations of using the price to book p b ratioinvestors find the p b ratio useful because the book value of equity provides a relatively stable and intuitive metric they can easily compare to the market price the p b ratio can also be used for firms with positive book values and negative earnings since negative earnings render price to earnings ratios useless there are fewer companies with negative book values than companies with negative earnings however when accounting standards applied by firms vary p b ratios may not be comparable especially for companies from different countries additionally p b ratios can be less useful for service and information technology companies with little tangible assets on their balance sheets finally the book value can become negative because of a long series of negative earnings making the p b ratio useless for relative valuation other potential problems in using the p b ratio stem from the fact that any number of scenarios such as recent acquisitions recent write offs or share buybacks can distort the book value figure in the equation when searching for undervalued stocks investors should consider multiple valuation measures to complement the p b ratio 