P/B ratio

The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market price to its book value. The calculation can be performed in two ways, but the result should be the same each way. In the first way, the company's market capitalization can be divided by the company's total book value from its balance sheet. The second way, using per-share values, is to divide the company's current share price by the book value per share (i.e. its book value divided by the number of outstanding shares).

As with most ratios, it varies a fair amount by industry. Industries that require more infrastructure capital (for each dollar of profit) will usually trade at P/B ratios much lower than, for example, consulting firms. P/B ratios are commonly used to compare banks, because most assets and liabilities of banks are constantly valued at market values. A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal (and/or that the market value of the firm's assets is significantly higher than their accounting value). P/B ratios do not, however, directly provide any information on the ability of the firm to generate profits or cash for shareholders.

This ratio also gives some idea of whether an investor is paying too much for what would be left if the company went bankrupt immediately. For companies in distress, the book value is usually calculated without the intangible assets that would have no resale value. In such cases, P/B should also be calculated on a "diluted" basis, because stock options may well vest on sale of the company or change of control or firing of management.

It is also known as the market-to-book ratio and the price-to-equity ratio (which should not be confused with the price-to-earnings ratio), and its inverse is called the book-to-market ratio.

Total book value vs tangible book value

Technically, P/B can be calculated either including or excluding intangible assets and goodwill.[1] When intangible assets and goodwill are excluded, the ratio is often specified to be "price to tangible book value" or "price to tangible book".

Value and limitations

Except in the case of a small minority of companies like property companies and investment trusts that are asset based, book values bear little or no relationship to true values of the companies. The items on the balance sheet are the result of various transactions, recorded using double entry at a particular point in time, to the extent that they do not form part of the profit and loss account to that point in time. The assets and liabilities comprising the book value are mainly stated at historic cost though a few items therein may be stated at valuations.

In many of today's companies, their most valuable assets are not shown on the balances sheet and are therefore not included in the book value. Book values are meaningless in companies such as Apple, Microsoft, Google, Facebook, GlaxoSmithKline, etc. where their intellectual capital, internally generated goodwill, brand awareness, etc. are much more valuable than the assets per their balance sheets but are not included therein. This generally leads the company's market value to be higher than its book value.

In Benjamin Graham's days, book values were more relevant as most companies then had significant investments in tangible assets and such assets comprised the bulk of the value of the company. The value of today's companies, other than asset based companies like investment trusts and property companies, is very different from the book values and there is no relationship between their intrinsic values and their book values. That is why Warren Buffett said "In all cases, what is clear is that book value is meaningless as an indicator of value" in his 2000 annual report.[2][3]

Despite the theoretical limitations of the price-book ratio, academic research has persistently shown that stocks with low price-book ratios persistently outperform stocks with high price-book ratios. Fama and French incorporated a price-book term in their influential three factor model. Penman Richardson and Tuna (2013) show how the ratio can be decomposed into financing and operating components. Foye and Mramor (2016) show that while stocks with low price-book ratios normally outperform, the ratios decomposed elements exhibit a different relationship with returns in different countries, implying that the price-book ratio may have a country-specific interpretation.[4]

gollark: Plus most of it's a statement and not an expression, so no composability.
gollark: Loads of different constructs.
gollark: Also, `for`/`else`?! Why?
gollark: Python *looks* simple, but has stupidly convoluted syntax with millions of special cases to make it stay simple-looking.
gollark: It's better than Java.

References
  1. Graham and Dodd's Security Analysis, Fifth Edition, pp 318 - 319
  2. "Book values".
  3. "Filters, sieves & screes".
  4. Foye, James; Mramor, Dusan (20 May 2016). "A New Perspective on the International Evidence Concerning the Book-Price Effect". SSRN 2782441. Cite journal requires |journal= (help)

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