A low price-to-book ratio, or P/B ratio, is an indication a stock may be undervalued, but because of all the variables involved, this is not necessarily the case. Consider other equity valuation measures to get a fuller picture of a stock's value and growth potential. The price-to-book ratio has been a much-favored metric for value investors, and values below 1.0 are basically considered a potentially undervalued stock. An important caveat is that a low P/B ratio can also indicate a company that is simply not functioning well and may be closer to bankruptcy than to explosive growth.
A number of variables, such as recent acquisitions or share buybacks, can throw off the P/B calculation, providing a misleading value. P/B is not considered the best valuation measure for service industry businesses since it does not factor in intangible assets. On the other hand, P/B ratio has been generally considered an excellent tool for evaluating capital-intensive companies and those with substantially larger than average assets.
P/B ratio is best looked at in relation to other equity valuation measures to determine its true implication, positive or negative. One metric used in conjunction with the P/B ratio is the return on equity ratio, or ROE. This tool measures the profit obtained from the equity of shareholders. In its simplest form, the ROE ratio reveals how efficiently a company is using what investors have put into it to generate further profits. The price-earnings ratio, price-cash flow ratio and return on capital employed ratio, or ROCE, provide other measurements to complement the P/B ratio evaluation.