What is P/B Ratio

Key Takeaways

• A company's market worth in relation to the value of its assets and costs is its price-to-book value (P/B) ratio.
  

• The P/B ratio may be used to identify potential investment opportunities.
  

• The price-to-book value ratio does not take into account the intangible assets of a company.
  

• A company with a P/B ratio of 1 or less is generally considered favourable for investment.
  

Understanding the true value of a company is important for making informed investment decisions. One metric that stands out in this regard is the price-to-book ratio. This financial ratio offers a unique perspective by comparing a company’s market value to its book value, providing insights that are not immediately apparent through market prices alone. But how exactly does this ratio work, and why is it important for investors seeking to uncover potential value opportunities?

What is Price-to-Book Ratio?

The price-to-book ratio, or the PBV ratio, is a method for determining the worth of a stock. It is a ratio of a company's market capitalisation to its book value. It can also be referred to as the ratio of book value per share to stock price per share of a company. Investors, banks, and other financial institutions frequently use it.

Many of the things on the balance sheet may be sold at greater or lower prices than their present value in the books. Yet, a company's book value is a pretty accurate estimate of its liquidation value in the case of bankruptcy.

Investors may get a better idea of how the market values a company by comparing the share price to its current book value. A high price-to-book ratio indicates that the market is optimistic about future performance. This is because the value they are assigning to the company surpasses the book value of its stock.

Formula To calculate the P/B Ratio

The price-to-book value ratio includes two key metrics of a company: market capitalisation and net asset value (NAV). So, to calculate the P/B ratio, you must have proper data on these two metrics.

To determine a company's market capitalisation, you have to multiply the stock's current market price by the total number of outstanding shares.

Market capitalisation = Stock's price x Number of outstanding shares

Now, the next step is to determine the net asset value of the company. For this, first sum up the book values of all the assets shown on a company's balance sheet. Then, subtract the total amount of all debts and obligations.

Book Value of Assets = Total Assets – Total Liabilities

This value reflects an organisation's equity value.

Using these two values, you can calculate the price-to-book value. The formula is as follows:

P/B Ratio = Market Capitalisation / Book Value of Assets

You can also calculate the price-to-book ratio using the following formula:

P/B Ratio = Market Price Per Share / Book Value of Assets Per Share

An Illustration of Price to Book Value Ratio

Let's analyse the process of determining the price-to-book ratio for company ABC. Assume they have 10,000 outstanding shares and a market price of ₹125 per share. So, the market capitalisation is ₹12,50,000 (₹125 x 10,000).

The balance sheet shows that they have total assets of ₹8,60,000 and total liabilities of ₹3,20,000. Their net asset value is thus equal to ₹5,40,000 (8,60,000– 3,20,000). This is the book value.

Therefore, the P/B ratio of company ABC is as follows.

P/B Ratio = Market Capitalisation / Book Value of Assets= ₹12,50,000 / ₹5,40,000 = 2.31

Uses of P/B Ratio

As an investor, you can use the P/B ratio for the following.

• While investing in a company, you should know the P/B ratio, which compares the price per share to the net asset value. Using this comparison, you can assess whether it is a wise investment or not.
  
• Many investors also want to know the value of the company's shares. The P/B ratio can be especially useful for evaluating companies in the banking, insurance, or investment industries.
  

However, as an investor, you must keep one thing in mind that companies maintain substantial assets, particularly those with significant R&D expenditures or long-term fixed assets, cannot benefit from this ratio.

Advantages of Using the P/B Ratio

Using the P/B ratio offers the following perks:

• Asset Focus: Unlike earnings-based metrics, the P/B ratio centres on a company’s tangible and intangible assets, excluding temporary market fluctuations in profits. This asset-driven perspective becomes particularly useful when analysing asset-heavy industries such as banking, insurance, and real estate, where balance sheet strength plays a more crucial role than short-term earnings.
  

• Risk Indicator: The ratio can serve as an indicator of downside risk. A stock trading close to or below its book value suggests that even if earnings weaken, the company still has significant tangible assets to fall back on. This provides a margin of safety, especially for investors concerned about capital preservation.
  

• Value Identification: For value investors, the P/B ratio is a reliable tool to detect mispriced stocks. A low ratio might reveal companies trading below the value of their net assets, signalling an opportunity for potential gains if the market eventually corrects the undervaluation.
  

• Distress Signal: The P/B ratio can act as an early warning sign when companies trade at extremely low valuations relative to book value. Such cases often indicate deeper structural issues such as poor asset quality, legal risks, or weak returns.
  

• Acquisition Relevance: The P/B ratio holds relevance in mergers and acquisitions. Acquirers often consider book value while negotiating deals. A company trading near or below the book value may attract acquisition interest, since buyers could obtain assets cheaper than building them internally.
  

Limitations of Price-To-Book Ratio

Let's now understand the limits of using the price-to-book value ratio.

• The sole factor considered for determining book value is the firm's monetary value. The P/B ratio excludes intangible economic assets, such as human capital.
  

• The book and market values of assets may fluctuate dramatically as a result of changes in technology, intellectual property, inflation, and other factors.
  

• The management's choice of accounting policies can significantly impact book value.
  

• The differences in book value may also result from the business model. The book value of assets of a firm that outsources production will be lower than that of a company that manufactures its products.
  

Importance of Price-To-Book Ratio in Share Market Analysis

Here is why the P/B ratio is important when doing stock market analysis:

Industry Comparison: The P/B ratio allows investors to compare companies within the same industry on a uniform metric. Since industries vary in capital intensity, comparing ratios across unrelated sectors may be misleading. However, within one industry, it highlights which companies trade at a premium or discount relative to their peers.

Return Correlation: There is a strong link between return on equity (ROE) and the P/B ratio. A company with consistent high ROE often trades at a higher P/B because the market values its ability to generate returns above asset value. This correlation helps investors align profitability metrics with valuation.

Capital Intensity: The importance of the P/B ratio increases in sectors where capital investment forms a major part of the balance sheet. Industries like power, telecom, or infrastructure rely heavily on assets to generate income. Investors use P/B to judge if the market price justifies the substantial capital employed.

Dividend Stability: Companies with low P/B ratios and strong asset bases are often capable of sustaining dividends, even in lean times. The tangible backing of assets provides a cushion for shareholders. Investors seeking stable dividend income use P/B to identify firms that can maintain pay-outs despite earnings volatility.

Inflation Adjustment: During high inflation periods, the book value of assets may not reflect their current replacement cost. A significantly low P/B ratio during such times may indicate undervaluation caused by outdated book values. Analysts adjust this perspective to ensure that valuation judgments remain relevant in inflationary environments.

Example of How to Use the P/B Ratio

Let’s take a detailed example of how to use the P/B ratio in stock analysis.

Suppose you are evaluating ABC Bank Ltd. Its stock is trading at ₹500 per share in the market. According to the company’s latest balance sheet, its book value per share (BVPS) is ₹250. To calculate the P/B ratio, you divide the market price by the book value per share:

P/B ratio = Market Price per Share ÷ Book Value per Share = ₹500 ÷ ₹250 = 2.0

This means investors are willing to pay twice the book value for every share of ABC Bank. Now, what does this tell you?

If ABC Bank’s peers in the banking sector are trading at an average P/B ratio of 3.5, then a P/B of 2.0 may indicate that ABC Bank is undervalued compared to its competitors. This could be due to temporary market pessimism, making it a potential buying opportunity for long-term investors.

However, if the bank is facing structural issues like rising non-performing assets or declining profitability, the lower P/B may actually reflect real concerns. Hence, while the P/B ratio is useful, it should be compared with peers and considered alongside other financial metrics.

Why Should You Consider P/B Ratio Before Investing Money?

The P/B ratio is a key metric that investors often check before investing money into a stock. It compares a company’s current market price with its book value (the net asset value on its balance sheet). A P/B ratio helps investors understand whether a stock is undervalued or overvalued compared to its actual assets.

For example, imagine two banks: Bank A and Bank B. Both have similar customer bases and loan portfolios. Bank A has a market price of ₹200 per share, and its book value per share is ₹100. This gives it a P/B ratio of 2 (₹200 ÷ ₹100).

Bank B trades at ₹90 per share, with a book value of ₹100, resulting in a P/B ratio of 0.9.

At first glance, Bank A looks more expensive, while Bank B seems undervalued since it is trading below its book value. However, P/B ratio must be assessed along with fundamentals. Bank A might have better management, lower bad loans, or higher growth prospects, which justifies a higher P/B. On the other hand, Bank B’s low P/B might reflect hidden risks such as poor asset quality.

Thus, considering the P/B ratio before investing helps investors avoid overpaying for a stock and helps identify undervalued opportunities.

Does Analysing P/B Ratio for Every Stock Make Sense?

For asset-heavy sectors like banks, real estate, and manufacturing, the P/B ratio is highly meaningful. These businesses own tangible assets such as property, machinery, or loans, and their book value closely reflects economic worth. A P/B ratio below 1 in such cases may suggest undervaluation, while a very high ratio may signal overpricing.

However, for technology firms, FMCG companies, or service-oriented businesses, relying only on the P/B ratio can be misleading. These companies derive much of their value from intangible assets, such as brand equity, intellectual property, or customer base, which are not reflected in their book value. As a result, their P/B ratios often appear unusually high without necessarily being overvalued.

Thus, while analysing the P/B ratio makes sense for certain sectors, it should not be used in isolation. A balanced approach, combining P/B with metrics such as P/E ratio, ROE, and cash flow, provides a clearer picture.

P/B Ratio vs Return on Equity

To better understand the company's financial health, it's essential to compare the price-to-book ratio with other key metrics, such as Return on Equity (ROE). While the P/B ratio measures the market's valuation of a company's book value, ROE indicates how effectively a company is using its equity to generate profits. A company with a high P/B ratio and low ROE might be overvalued, whereas a company with a low P/B ratio and high ROE could be undervalued. Here's a quick comparison:

P/B ratio vs Price to Tangible Book Ratio

Another useful comparison is between the price-to-book ratio and the price-to-tangible-book ratio (PTB). While the P/B ratio's meaning includes all assets, the PTB ratio excludes intangible assets. This can provide a clearer picture of a company's tangible net worth. For instance, a company with significant intangible assets might have a high P/B ratio but a more reasonable PTB ratio, making it a better investment.

Interpreting Price-To-Book Ratio

Intangible assets are excluded from the book value used in the computation, so the P/B ratios of such firms may appear higher than expected. Microsoft, Google, and Tesla are a few examples of such companies. Yet, the P/B ratio might be a crucial instrument for assessing a capital-intensive organisation. These companies have a lot of physical assets. Banks are one such example.

Low Price-To-Book Ratio: A low P/B ratio of less than 1.0 means that the stock price is trading below the company's book value. Low P/B ratios can indicate that a firm is undervalued. They can also indicate major internal issues. Therefore, a thorough analysis is necessary.

P/B Ratio of 1 to 3: A P/B ratio of 1 to 3 indicates that the stock price is trading at about the company's book value. A stock is considered to be selling at a premium when its P/B ratio is assessed to be higher than 1.0. Most of the stocks have a P/B ratio between 1 and 3.

Price-To-Book Ratio Exceeding 3.0: A high P/B ratio of more than 3.0 indicates that the stock price is trading above the company's book value. A high price-to-book ratio means the company is overvalued and has no assets. However, this may also be a result of the P/B ratio's restriction, which prevents it from taking into account factors such as intangible assets or forecasts for future earnings. Due to the exclusion of their intangible assets from the computation, many excellent firms might have high P/B ratios.

How Do You Determine a Good Price-To-Book Ratio?

The ideal price-to-book ratio varies depending on the type of business. Value investors typically regard a P/B ratio of less than 1.0 as a sign of an undervalued stock. A P/B ratio of less than 3 is acceptable to the majority of investors. However, the definition of a "good P/B ratio" is not absolute.

Businesses related to the IT sector have a large amount of intangible assets. Thus, a P/B ratio of less than 3.0 might be a favourable one. For businesses that have a lot of physical assets, like those in the banking industry, a P/B ratio of more than 1.5 might be problematic.

In general, you need a low P/B when compared to other firms in the same industry.

Conclusion

The price-to-book value (PBV) ratio compares the market capitalisation and the net assets of a company. As an investor, you can use the P/B ratio to select undervalued stocks. However, it does not take into account the intangible assets of a company. Therefore, it is advisable to consider other ratios before investing. Good trading platforms like Kotak Securities provide several indicators and tools for analysing stocks on different parameters. The PBV ratio can be used to select companies in capital-intensive industries, such as transportation and telecommunications. To choose appropriate stocks, it is crucial to contrast a firm's PBV ratio with the PBV ratio of the particular industry.