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How is price-to-book value used?
A favorite of strict value investors, the price/book ratio (market price per share divided by book value per share) gives some idea of whether you’re paying a little or a lot for what would be left of the company if it went out of business immediately. A price/book ratio of less than one is interesting to value hunters. One reason is that basic accounting principles, geared to err on the side of conservatism, typically understate a company’s book value, since assets must be accounted for at cost less depreciation. Thus, a factory could have little or no value on the balance sheet even though, if it were for sale, it might bring millions. Given all this, a very low price to book ratio makes some fundamental investors feel that an ability to generate earnings as well is almost a bonus. As with most ratios, this one will vary by industry. The price/book ratio can be especially useful in any field where asset values are fairly certain. The thrift industry is one example; since a thrift’s financial assets are much easier to value than those of an industrial concern, the price/book ratio for a thrift is not as subject to accounting vagaries. The Price/Book Ratio for an entire portfolio is the weighted average of the price/book ratios of all the stocks in a mutual fund’s portfolio.Return to Questions
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