Loading the player...

What is 'Price-To-Book Ratio - P/B Ratio'

Companies use the price-to-book ratio to compare a firm's market to book value by dividing price per share by book value per share. Some people know it as the price-equity ratio.

We can calculate this as:

P/B ratio = market price per share / book value per share

In this equation, book value per share =  (total assets - total liabilities) / number of shares outstanding

A lower P/B ratio could mean the stock is undervalued. However, it could also mean something is fundamentally wrong with the company. As with most ratios, this varies by industry.

This ratio also indicates whether you're paying too much for what would remain if the company went bankrupt immediately.

For more, check out Digging Into Book Value

BREAKING DOWN 'Price-To-Book Ratio - P/B Ratio'

The P/B ratio reflects the value that market participants attach to a company's equity relative to its book value of equity. A stock's market value is a forward-looking metric that reflects a company's future cash flows. The book value of equity is an accounting measure based on the historic cost principle, and reflects past issuances of equity, augmented by any profits or losses, and reduced by dividends and share buybacks.

The Differences Between the Market and Book Value of Equity

Due to accounting conventions on treatment of certain costs, the market value of equity is typically higher than the book value of a company, producing a P/B ratio above 1. Under certain circumstances of financial distress, bankruptcy or expected plunges in earnings power, a company's P/B ratio can dive below 1. Because accounting principles do not recognize brand value and other intangible assets, unless the company derived them through acquisitions, companies expense all costs associated with creating intangible assets immediately. For example, companies must expense research and development costs, reducing a company's book value. However, these R&D outlays can create unique production processes for a company or result in patents that can bring royalty revenues going forward. 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.

Advantages and Disadvantages to the P/B Ratio

Investors 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. Also, the P/B ratio can be used for firms with positive book values and negative earnings since negative earnings render price-to-earnings ratios useless, and 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. Also, 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.

RELATED TERMS
  1. Book-to-Market Ratio

    The book-to-market ratio is a ratio used to find the value of ...
  2. Current Ratio

    The current ratio is a liquidity ratio that measures a company's ...
  3. Asset Valuation

    Asset valuation is the process of determining the fair market ...
  4. Cash Asset Ratio

    The cash asset ratio is the current value of marketable securities ...
  5. Key Ratio

    Key ratios are the main mathematical ratios that illustrate and ...
  6. Book Value Reduction

    A book value reduction takes place when writing down the value ...
Related Articles
  1. Investing

    Using The Price-To-Book Ratio To Evaluate Companies

    The Price-To-Book (P/B) ratio can be an easy way to determine a company's value, but it isn't magic!
  2. Investing

    Book Value: How Reliable Is It For Investors?

    In theory, a low P/B ratio means you have a cushion against poor performance. In practice, it is much less certain.
  3. Investing

    5 must-have metrics for value investors

    In this article, we outline the five ratios that can help value investors find the most undervalued stocks in the market.
  4. Investing

    The 4 basic elements of stock value

    Investors use these four measures to determine a stock's worth. Find out how to use them.
  5. Investing

    Analyzing AT&T's Price & Profitability Ratios in 2016 (T)

    Conduct fundamental analysis on AT&T by examining its price and profitability ratios.
  6. Investing

    Investing By The Book

    Buying below book value can provide investors with a safe and consistent investment approach.
  7. Investing

    Deep Discount-To-Book Value Stocks

    With the right company, buying at a discount-to-book value could prove fruitful.
  8. Managing Wealth

    Value Investing + Relative Strength = Higher Returns

    Buying value stocks that are moving higher helps investors steer clear of value traps.
  9. Investing

    How to Find Solid Buy-and-Hold Stocks

    Find out how adding solid buy-and-hold stocks to your portfolio can lead to long-term profits with these fundamental and contrarian indicators.
  10. Investing

    Hewlett-Packard Company's 3 Key Financial Ratios (HPQ)

    Appreciate the business complexity behind the financial ratios for HP and understand how the ratios may be stated differently after the company's split.
RELATED FAQS
  1. What Is the Average Price-To-Book Ratio for a Bank?

    Learn what the average price to book (P/B) ratio is in the banking industry and how the corporate stock evaluation metric ... Read Answer >>
  2. What metrics can be used to evaluate companies in the financial services sector?

    Explore some of the various equity evaluation metrics that can best be used to assess companies included in the financial ... Read Answer >>
  3. If the intrinsic value of a stock is significantly lower than the market price, should ...

    Discover how the intrinsic value and market price of a stock are related and why a stock that appears overvalued may still ... Read Answer >>
  4. How Are Book Value and Market Value Different?

    Book value and market value are two financial metrics used to determine the valuation of a company and whether the stock ... Read Answer >>
Trading Center