A stock is termed as undervalued if it has a lower P/B ratio. A low P/B ratio may also mean a company has some problems with its fundamentals.
A financial ratio that is used to compare market value of a stock to its book value is called price to book ratio or P/B ratio. The financial ratio is derived by dividing the current closing price of a share by the book value of a share in the latest quarter. The ratio is also recognised as ‘price-equity ratio’ in the financial world.
How is P/B ratio calculated?
P/B Ratio = market price per share / book value per share
Book Value per Share = (Total Assets – Total Liabilities) / Number of shares outstanding
What does P/B ratio indicate?
A stock is termed as undervalued if it has a lower P/B ratio. A low P/B ratio may also mean a company has some problems with its fundamentals. However, the ratio varies by industry as in the case of most other financial ratios. P/B ratio also provides an idea on whether an investor is paying too much to buy a stock for what would be left with if the firm goes bankrupt the next second.
How is it useful for investors?
The ratio is very much preferred by the investors as the book value of equity provides a relatively stable parameter that can be easily compared to the market price of a stock. The ratio can be used for companies with positive book values and negative earnings because in such a case negative earnings render price-to-earnings ratios futile. Nevertheless, P/B ratios may not be much comparable especially when comparing firms from different countries as per the accounting standards usually applied by the firms the world over.