Understanding the Price-to-Book Ratio

One of the most commonly used ratios investors use to gauge a company’s value is the price-to-book-value ratio, or P/B ratio. The book value of a company is what’s left when all its liabilities are deducted from its assets.

So, the P/B ratio simply denotes how much investors are paying for each dollar of book value a company has. It is calculated by dividing a company’s share price with its book value per share.

How to use the P/B ratio

Some value investors like to use the P/B ratio. They would find potential bargains by filtering for stocks that are trading at a P/B ratio of less than 1. Such stocks give investors the opportunity to buy a company’s assets for less than they’re worth.

The P/B ratio is particularly useful when it comes to capital-intensive businesses or financial institutions. In the case of the former, companies or trusts that own properties (think real estate investment trusts) are a good example. For the latter, good examples are banks and insurance companies.

But, the P/B ratio is far from perfect. It is not effective for analysing serviced-based businesses or technology companies because such companies tend to hold little assets on their balance sheets. Their assets are not what really drives the value of their businesses.

A Foolish conclusion

The P/B ratio can be useful when applied to companies in asset-heavy industries. It can also be a time-saver by acting as a filtering tool to quickly sieve out stocks that are worthy for further assessment.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore James Yeo doesn’t own shares in any companies mentioned.