Price-to-Book (PB) Ratio: Meaning, Formula, and Example

What Is the Price-to-Book (P/B) Ratio?

Many investors use the price-to-book ratio (P/B ratio) to compare a firm's market capitalization to its book value and locate undervalued companies. This ratio is calculated by dividing the company's current stock price per share by its book value per share (BVPS).

KEY TAKEAWAYS

• The price-to-book (P/B) ratio measures the market's valuation of a company relative to its book value.

• The market value of equity is typically higher than the book value of a company's stock.

• The price-to-book ratio is used by value investors to identify potential investments.

• P/B ratios under 1.0 are typically considered solid investments by value investors.

• A good P/B ratio is relative to a business and its industry.

Formula and Calculation of the Price-to-Book (P/B) Ratio

The formula for the price-to-book ratio is:

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• Market Price per Share = Current market price of the share

• Book Value per Share = (Total assets - intangible assets - total liabilities) ÷ number of outstanding shares

Market value per share is obtained by looking at the information available on most stock tracking websites. You need to find the company's balance sheet to obtain total assets, total liabilities, and outstanding shares. Most investment websites display this financial report under a "financials" tab—some show it on a stock's summary tab.

What the Price-to-Book Ratio Can Tell You

The P/B ratio reflects the value that market participants attach to a company's equity relative to the book value of its equity. Many investors use the P/B ratio to find undervalued stocks. By purchasing an undervalued stock, they hope to be rewarded when the market realizes the stock is undervalued and returns its price to where it should be—according to the investor's analysis.

Some investors believe that the P/B ratio is a forward-looking metric that reflects a company's future cash flows; however, when you look at the information used to calculate the P/B ratio, the factors used are the price investors are willing to pay currently, the number of shares issued by a company, and values from a balance sheet that reflect data from the past. Thus, the ratio isn't forward-looking and doesn't predict or indicate future cash flows.

The P/B ratio also provides a valuable reality check for investors seeking growth at a reasonable price. It is often evaluated with return on equity (ROE), a reliable growth indicator. Large discrepancies between the P/B ratio and ROE often raise a red flag for investors. 

A high P/B ratio suggests a stock could be overvalued, while a lower P/B ratio could mean the stock is undervalued.

As with most ratios, the P/B ratio varies by industry. A company should be compared with similarly structured companies in similar industries; otherwise, the comparison results could be misleading.

P/B Ratios and Public Companies

It is difficult to pinpoint a specific numeric value of a "good" price-to-book (P/B) ratio when determining if a stock is undervalued and therefore, a good investment. It's helpful to identify some general parameters or a range for P/B value, then consider various other factors and valuation measures that more accurately interpret the P/B value and forecast a company's potential for growth.

The P/B ratio has been favored by value investors for decades and is widely used by market analysts. Traditionally, any value under 1.0 is considered desirable for value investors, indicating an undervalued stock may have been identified. However, some value investors may often consider stocks with a less stringent P/B value of less than 3.0 as their benchmark.

Equity Market Value vs. Book Value

Due to accounting procedures, the market value of equity is typically higher than a security's book value, resulting in a P/B ratio above 1.0. During times of low earnings, a company's P/B ratio can dive below a value of 1.0.

For example, in most cases, companies must expense research and development costs, reducing book value because this includes the expenses on the balance sheet. However, these R&D outlays can create unique production processes for a company or result in new patents that can bring royalty revenues. While accounting principles favor a conservative approach in capitalizing costs, market participants may raise the stock price because of such R&D efforts, resulting in wide differences between the market and book values of equity.

What Is a Good Price-to-Book Ratio?

What counts as a “good” price-to-book ratio will depend on the industry in question and the overall state of valuations in the market. An investor assessing the price-to-book ratio of a stock might choose to accept a higher average price-to-book ratio, as compared to an investor looking at a the stock of a company in an industry where lower price-to-book ratios are the norm.