The price to book ratio is renowned as an important financial valuation tool. Essentially, it is utilized in an attempt to appraise if a stock of a firm is undervalued or overvalued. It does that by comparing the net assets of the firm with the price of the existing shares. Fundamentally, it is supposed to differentiate between the total share price of a firm and the book value.
This financial tool will point out the major difference between these two. So, the market value represents the current stock price of the existing shares. This is actually the approximate worth of the company, according to the market. On the other hand, in regard to the book value, it is derived from the balance sheet of a firm. In other words, it represents the net assets of a given firm.
To that end, it is a critical tool for financial analysts and investors, for distinguishing between investor speculation and the accurate value of a publicly traded company. Let’s take an example; a company that doesn’t own any assets or doesn’t have a visionary plan or anything of the kind can, nevertheless, attempt to create a lot of hype around it, to make it appealing to potential investors.
This strategy will make the stock price to grow from quarter to quarter. Even so, this doesn’t mean that the book value of the company has changed in any way, as the business doesn’t own any assets.
Calculating the Price to Book Ratio
The price to book ratio = market price per share/book value per share. Expressly, the market share per price stands for the current stock price the company is being traded at on the market.
Conversely, the book value per share is a tad more complex. What you have to do is to subtract the total liabilities from the total amount of assets. Afterward, you divide the difference by the total number of shares at that given date.
In fact, this equation can be used in a different manner, as many investors choose to do; e.g.: market to book ratio = total book value/total market value.
Distinct from the PB ratio, the MB formula looks at the firm’s values on a company-wide basis. More specifically, it doesn’t assess individual shares.
Normally, if the PB ratio is over 1, then, this would mean that investors are willing to pay more than the company’s net assets. More specifically, that would imply that the firm has a healthy future in terms of profitability – this is why investors are open to paying more for this prospect.
Nonetheless, considering that the market book ratio is less than 1, then, the firm’s stock price is selling for less than the actual worth of the assets. Usually, if a company is undervalued, it is due to a significant reason.
To conclude, the price to book ratio doesn’t factor in the dividends. Additionally, there are many other details that aren’t taken into consideration, which is why one shouldn’t rely entirely on this specific formula.