1. What is price-to book value ratio?
The ratio helps in understanding how many times the stock is trading over and above the company's book value. It is the total value of the company's assets that shareholders would theoretically get if the company were to wind up.
2. How to calculate PB and why is it used?
PB ratio is calculated by dividing the current market price of the stock with the book value of the company . For example, if a company's book value per share is `50 apiece and the stock price is `250 then the PB ratio is 5. Value investors use it as a tool to identify low priced stocks with high growth prospects.
3. How to use it to invest in cos?
The PB ratio is useful only when you are looking at busi nesses that are capital intensive. The basic definition is that priceto-book ratio lower than 1 could mean that the stock is undervalued. In a raging bull market it can also mean that something is fundamentally wrong with the company . Conversely , a stock with a PB ratio of more than 1 can be viewed as relatively expensive or overvalued.
4. How do investors look at this ratio in practice?
Fund managers say that PB ratio needs to be looked at in the context of return on equity. For example, a company with a high RoE will always command a higher PB ratio and vice versa. It is used mostly to compare banks as most assets and liabilities of banks are valued at market value.
5. What are the drawbacks?
It does not take into account fac tors such as goodwill, brand name and intellectual property . In particular, it is less useful in understanding the value of service-oriented companies that do not have significant tangible assets. For example, technology firms do not need much physical capital to create earnings. It is also not much useful in understanding companies that have high debt.
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