Revealed: The price to book ratio explained

Fsp Invest, 21 Nov. 2013

Tags: price to book ratio, p/b ratio, what is the p/b ratio, financial ratios, fundamental analysis, investing, how to calculate the p/b ratio,

If you’re searching for a company that’s undervalued, one ratio worth calculating is the price to book (P/B) ratio. It is a great way to value a firm. But how do you calculate it? Read on to find out what you need to know about the price to book ratio…

The price to book (P/B) ratio is a great tool to have in your investor toolkit, Tim Bennett in MoneyWeek explains…

To calculate the P/B ratio, you need the current share price and the net asset value per share.

You should find the net asset value in the latest accounts of the company you’re looking at. If it’s not on a per share basis, you just need to divide the number provided and divide by the number of shares in circulation.

For example, say the firm has a ‘book value’ (net asset value) of R100 million. If it has 100 million shares in issue, the book value is R1 (R100 million/100 million).

Price to book = Current share price/ net asset value per share

Let’s have a look at an example of calculating the P/B ratio…

If the current share price is R1.25 then the P/B is R1.25/R1, or 1.25 times.

What the P/B ratio tells you

In short, the lower the number the better.

If you are looking for a bargain, you ideally want it to be less than one. A ratio of 1.25, as in the example above, suggests you are paying R1.25 for assets that are currently only worth R1. That’s not much of a bargain, at least on the face of it.

You’d be much more interested if the result had come out at 0.8. Because then you’d be paying just 80c for assets with a value of R1.

However, like other ratios, it has some weaknesses and can be misleading. A low P/B could signal something is wrong with the company. So never use it in isolation.

So there you have it, what you need to know about the price to book ratio.

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