The price to book ratio (P/B ratio) determines how over or undervalued a company stock is. When you are picking out a stock to invest in, how can you tell if it will pan out? The price to book ratio can give you a good estimation of this. It compares a company’s market value to its book value and is also known as the market to book ratio or M/B ratio.
The “market value” of a company is the amount that their stock is selling for on the stock market. You can find the market value of a company on any individual stock analysis. The “book value” is the minimum cash value of a company after its equity. Simply put, comparing these two metrics looks at how they are selling shares compared to how they could be selling them. Investors typically prefer stocks that are considered undervalued.
When it comes to the stock market, an “undervalued” stock means that while the stock is currently selling low, it has potential. The estimated future value of the stock could be significantly higher. Because of this, the price per share would not be an accurate reflection of the quality of the company. This would mean that this stock would probably be a good investment for future gain.
Price To Book Ratio Formula
In order to use the price to book ratio, you will need to first have (or calculate) two variables. First, you will need to know the price per share. Essentially, this is the same as the market price. This number would be the current cost of one share of the company. You should be able to easily identify this amount for any publicly-traded company on its stock analysis.
You also need to calculate the book value per share. This is the same concept as the book value, except you need to find that number for each individual share. This number would tell you the minimum amount that each common shareholder would be entitled to if the company were to liquidate. To find this amount, you would subtract preferred equity from the company’s total equity, then divide the result by the number of shares outstanding (or the sum of all their shares).
If a company’s price to book ratio is over one, this would imply that investors on the market value a company’s worth to be higher than its net assets. A company with this ratio would be healthy now and would have proved its stability.
Usually, a price to book ratio of less than one is found in fledgeling companies. These stocks can give investors a great margin. This could be considered an undervalued stock with the potential to provide a solid return. However, a ratio of less than one can also be dangerous. The company would be trading below its asset value and could be losing money. Due to this risk, it’s important to include other factors in your overall evaluation of a stock’s performance.
Price To Book Ratio Example
Robin is considering purchasing a stock for a burger place she loves. But first, she wants to know if it would be a sound investment. She looks up their stock analysis and learns that their price per share is $33.03. The book value per share is $28.39. What would be the company’s price to book ratio?
Let’s break it down to identify the meaning and value of the different variables in this problem.
- Market Price Per Share: $33.03
- Book Value Per Share: $28.39
We can apply the values to our variables and calculate the P/B ratio:
In this case, the burger company’s price to book ratio would be 1.16.
From what we know about the price to book ratio, Robin would most likely be making a fairly secure investment. While the margin may not be as good, she would probably be investing in a secure, established restaurant. If she wanted something with a higher potential for return, she might consider finding a stock with a lower price to book ratio.
Price To Book Ratio Analysis
The price to book ratio is a useful way to assess the potential of a new investment. Just like in any investment, you want to have a good understanding of the risks as well as the potential rewards. If the company were to liquidate, would you have overpaid for the value of your share?
This ratio is especially helpful for investors who practice value investing. The term “value investing” means that they look for stocks that are selling at less than their book value. While these can be riskier, they provide the best return over time. In these situations, they would be able to get in on the ground floor of the purchase and make more money as the company grows.
The formula can also help you have a better understanding of a company’s health if they are in an industry with a less consistent income; Financial institutions often fall in this category. You can also compare companies within an industry as you are choosing the best place to invest your money.
Still, whatever evaluation you are making should not include the price to book ratio alone. It is highly recommended that you include other identifiers that focus on the company’s profits and revenue in addition to the stock price. You could also look at the Stock Return for the benefits from a shareholder’s perspective.
Price To Book Ratio Conclusion
- The price to book ratio determines how undervalued or overvalued a company stock is on the market.
- The price to book ratio requires two variables: the market price per dhare and the book value per share.
- A ratio of less than one means that the company could be undervalued and would provide a better return in the future.
- A ratio of more than one would suggest that the investment is more secure.
Price To Book Ratio Calculator
You can use the price to book ratio calculator below to quickly determine how undervalued a company stock is by entering the required numbers.
FAQs
1. What is the price to book (P/B) ratio?
The price to book (P/B) ratio is a calculation that compares the market price of a share to the book value of the company's equity per share.
2. How is price to book ratio calculated?
The price to book ratio is calculated by dividing the market price per share by the book value per share.
3. What is considered a good price to book ratio?
A good price to book ratio is anything below 1, as this would suggest that the company is undervalued. A ratio above 1 would suggest that the investment is more secure.
4. What does a high price to book ratio mean?
A high price to book ratio means that the market value of a company's equity is higher than the book value. This suggests that the investment may be overvalued.
5. Why is the price to book ratio important?
The price to book ratio is important because it can help investors determine whether a company is undervalued or overvalued. It can also help investors decide whether to invest in a company.
