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A common valuation measure is the price/book ratio (P/B), which relates a stock’s market value with its book value (also known as shareholder equity) from the latest balance sheet. Book value can be thought of as what would be left over for shareholders if a company shutters operations, pays off its creditors, collects from its debtors, and liquidates itself.
Things To Know
- Price/book ratio relates a stock’s market value with its book value.
Here are the formulas to know:
Book Value Per Share = (Total Shareholder Equity) / (Shares Outstanding)
P/B = (Stock Price) / (Book Value Per Share) = (Market Capitalization) / (Total Shareholder Equity)
P/B has its limits
As with the other ratios used, there are caveats to using P/B. For instance, book value may not accurately measure a company’s worth, especially if the firm possesses significant intangible assets such as brand names, market share, and other competitive advantages. The lowest price/book ratios tend to be in capital-intensive industries such as utilities and retail, whereas the highest P/B ratios are in fields such as pharmaceuticals and consumer products, where intangibles are more important.
Price/book is also tied to return on equity (ROE), which is net income divided by shareholder equity. Given two companies that are otherwise equal, the one with the higher ROE will have a higher P/B ratio. A high P/B shouldn’t be cause for alarm, especially if the company continually earns a high ROE.