Price to Book Value

What is Price to Book Value (P/B) Ratio?

Price to Book Value Ratio or P/B Ratio is one of the most important ratios used for Relative Valuations. It is usually used along with other valuation tools like PE Ratio, PCFPCFPrice to Cash Flow Ratio is a value indicator that measures a company's stock price in relation to the cash flow amount it generates. This is determined as the ratio of Price Per Share to Operating Cash Flow Per Share. read more, EV/EBITDAEV/EBITDAEV to EBITDA is the ratio between enterprise value and earnings before interest, taxes, depreciation, and amortization that helps the investor in the valuation of the company at a very subtle level by allowing the investor to compare a specific company to the peer company in the industry as a whole, or other comparative industries.read more, etc. It is most applicable for identifying stock opportunities in Financial companies, especially Banks.

In this article, we discuss the nuts and bolts of Price to Book Value Ratio.

Price to book value ratio is one of the relative valuation tools used to measure stock valuation.  The price to book value compares the current market price of the share with its Book value (as calculated from the Balance Sheet).

Price-to-Book-Value

You are free to use this image on your website, templates etc, Please provide us with an attribution linkHow to Provide Attribution?Article Link to be Hyperlinked
For eg:
Source: Price to Book Value (wallstreetmojo.com)

Price to Book Value Ratio = Price Per Share / Book Value Per ShareBook Value Per ShareThe book value per share (BVPS) formula evaluates the actual value of the common equity for each outstanding share, excluding the preferred stock value. A higher BVPS compared to the market value per share indicates an overvaluation of stocks and vice-versa.read more

Please note that Book value = Shareholder’s Equity = Net Worth.

They all are one and the same!

If this ratio of the stock is 5x, this implies that the current market price of the share is trading at 5 times the book value (as obtained from the balance sheet).

Price to Book Value Calculation

Let us now apply Price to Book Value formulaBook Value FormulaThe book value formula determines the net asset value receivable by the common shareholders if the company dissolves. It is calculated by deducting the preferred stocks and total liabilities from the total assets of the company.read more to calculate Citigroup P/B Ratio. First, we require Citigroup’s Balance sheet details. You may download Citigroups 10K report from here.

The below table shows the Consolidated Shareholder’s equity section found on Page 133

Citigroup Price to Book Value Calculation

From the table above, Citigroup’s shareholders’ equity is $221,857 million in 2015 and $210,185 million in 2014.

Corresponding common stock outstanding numbers are 3,099.48 million shares in 2015 and 3,083.037 million in 2014.

Citigroup’s Book value in 2015 = $221,857 / 3099.48 = 71.57

Citigroup’s Book value in 2014 = $210,185 / 3,083.037 = 68.174

Price of Citigroup as of 4th march, 2016 was $42.83

Citigroup P/BV 2014 = $42.83/71.57 = 0.5983x

Citigroup P/BV 2015 = $42.83/68.174 = 0.6282x

Also, note that Assets = Liabilities  + Shareholder’s Equity (Simple accounting equationAccounting EquationAccounting Equation is the primary accounting principle stating that a business's total assets are equivalent to the sum of its liabilities & owner’s capital. This is also known as the Balance Sheet Equation & it forms the basis of the double-entry accounting system. read more)

Shareholder’s Equity or Book Value = Assets – Liabilities.

If you wish to brush up your accounting basics, you can look at this Basic Accounting Tutorial.

In the case of Citigroup, we could have also used an alternated formula, as provided above.

P/B Ratio of Software Companies

In this section, we see how the P/B Ratio of Software companies is calculated, whether it makes sense for us to apply the P/B Ratio for valuing Software companies. The case study under consideration here is Microsoft.

As the first step, please download Microsoft 10K Report for Balance Sheet Details.

Microsoft Price to Book Value 1

Key Observation of Microsoft Balance Sheet (in the context of Book Value)

With a general understanding of a Software company’s balance sheet, let us now look at the Historical P/B Ratio of some of the Internet/Software companies.

The below graph shows a quick comparison of the Historical Book values of Microsoft, Google, Citrix, and Facebook.

Software companies Price to Book Value

source: ycharts

Key Observations

Other sectors where you will find higher Price to Book value ratio and CANNOT apply P/B Ratio

  • Internet Companies like Amazon, JD.com, Google, Alibaba, eBay
  • FMCG Companies like Colgate, P&G, Walmart, Cadbury, Coca-cola

P/B Ratio for Automobile Companies

As noted above, the P/B Ratio is not the right valuation multiple for Internet Companies. In this section, let us evaluate if it makes sense for automobile companies or not. We take an example of General Motors.

You can download General Motors 10K report from here.

General Motors Price to Book Value

Key Observation on General Motors Balance Sheet

  • General Motors have a higher proportion of Tangible Assets as a % of total assets (more than 30%)
  • General Motors assets include Inventories, Capital and Operating Leases, and Other assets
  • Intangible Assets is much lower (less than 3% of the total asset size)
  • Since the balance sheet contains a higher proportion of tangible assets, we can apply the Price to Book value ratio as a valuation proxy.

The below graph shows a quick comparison of the Historical Book values of General Motors, Ford, Toyota Motors, and Nissan.

Automobile comapnies PB Ratio

source: ycharts

Key Highlights of Price to book value ratio of Automobile Companies

Automobile companies generally have a Price to Book value ratio of greater than 1.0x.

This normally happens because their asset book value tends to underestimate their replacement value.

Even though we can apply a P/B ratio as a proxy for the automobile company’s valuation, it is still noted the primary valuation tool for such capital-intensive sectors. However, you may find some analysts taking this into consideration in the comparable comp table.

Other capital-intensive sectors where PB can be used as a proxy valuation tool.

  • Industrial Firms like Siemens, General Electric, BASF, Bosch, etc
  • Oil and Gas Companies like PetroChina, Sinopec, Exxon Mobil, Royal Dutch Shell, BP, etc.

Why is the P/B Ratio used in Banking?

From the above, we have noted that P/B ratios cannot be applied to Internet and software companies. However, we can still use these ratios as a proxy for capital intensiveCapital IntensiveCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.read more companies like automobiles and Oil & Gas. Let us now look at if Price to book value makes sense for Financial Sectors.

Let us look at the Balance Sheet of Citigroup. You may download Citigroups 10K report from here.

Citigroup Balance Sheet Assets

Key Observation of Citigroup’s Balance Sheet

  • Banks have assets and liabilities which are periodically marked to market, as it is mandatory under regulations. So, the Balance Sheet value represents the market value, unlike other industries where the Balance Sheet represents the historical cost of the assets/liabilities.
  • Bank assets include investments in government bonds, high-grade corporate bonds or municipal bonds, along with commercial, mortgage, or personal loans that are generally expected to be collectible.

The below graph shows a quick comparison of the Historical Book values of JPMorgan, UBS, Citigroup, and Morgan Stanley.

Bank Price to Book Value

source: ycharts

Why Price to Book Value ratio can be used to value Banking Stocks

Historical P/B ratio vs. Forward P/B

Like the Trailing PE and the Forward PE, we can have a similar formula for Price to Book Value.

Historical P/B  = Current Price / Book Value (historical)

Forward P/B = Current Price / Book Value (Forward, forecast)

The price to book value of history is relatively straightforward to find out from the balance sheet. However, the forward Book Values might get slightly tricky.

There are two things that you can do to obtain the book value –

  • The easier (and expensive) way is to get access to Factiva or Bloomberg, where we get such data in an easily downloadable format. You just need to provide the ticker and download the consensus book to the value forecast.
  • The difficult one is to prepare the financial model and project Balance Sheet of the company under consideration. It involves preparing a full three statement financial model. If you want to learn more about Financial modeling from scratch, you can take this Financial modeling in Excel.

Let us take an example to see how we can incorporate Trailing and Forward Price to Book Value ratio to identify the cheapest and most expensive stock from the consideration set.

Example

Calculate the historical PB and Forward PB

AAA Bank, Historical Book Value is $500.0, and its Current Market Price is $234.

Trailing P/B Ratio = $234 / $500 = 0.5x

Likewise, we can calculate Forward Price to Book Value ratio of AAA Bank. AAA 2016 estimated Book Value is $400.0, and its current price is $234.

Forward P/B Ratio = $234 / $400 = $0.6x

Some of the things to consider regarding the Historical and Forward Price to Book Value Ratio

  • If Book Value is expected to increase, then the Forward P/B ratio will be lower than the Historical Ratios. We can observe this in the case of BBB Bank and CCC Bank, where the Book Value forecast increases in 2016 and 2017.
  • However, if Book Value is expected to show a decline in the future, then you will note that the Forward P/B ratio will be higher than the Historical P/B Ratio. This can be observed in Bank AAA and Bank EEE, where the Book value declines each year.
  • There can also be a case where book value does not show any trend. For example, Bank DDD, where we see that Book value increases in 2016 and thereby decreases in 2017. In such cases, we will not see any particular trend in the Price to Book Value Ratio.

How to use Price to Book Ratio for valuations?

Let us start with the table that we have above. Assuming that this comparable comp lists relevant competition and important financial numbers like  Price, Market Cap, Book value, etc.

Can you guess which is the cheapest and the most expensive bank from the above table?

Hint – Take into consideration both the Historical P/B Ratio and Forward P/B Ratio.

Which is the cheapest bank?

  • The cheapest Bank from the table provided is AAA Bank. Its Historical Price to Book Value ratio is 0.5x, and the forecast is 0.6x and 0.7x in 2016 and 2017
  • However, I feel there is a catch here. The book value is declining each year, and the forward P/B ratio may increase further. The declining book value can be due to limited growth opportunities or maybe due to forecasted losses.
  • For me, Bank BBB may be a safe bet, given its Book value is growing, and its P/B ratio is closer to 1x in the future.

Which is the Most Expensive bank?

  • There can be two banks under consideration for the most expensive bank – Bank CCC and Bank EEE.
  • Looking at the book value numbers of EEE, it seems that they are experiencing losses each year, thereby leading to a decrease in book value.
  • However, Bank CCC is showing an increase in book value in future years, thereby making it a safer bet.
  • I think I will refrain from Bank EEE as compared to Bank CCC due to the reasons above.

Relationship between P/B Ratio and ROE

The price to book value ratio is closely related to the ROE of the company.

(Price/Book Value Per share) = (Price/EPS) x (EPS/Book Value Per share)

Now, Price/EPS is nothing but PE ratioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more.

EPS/Book value per share formula is ROE (remember, ROE = Net Income / Shareholder’s Equity or Book Value)

Because of its close linkage to return on equity (price to book is PE multiplied by ROE), it is useful to view price to book value together with ROE

  • General Rule of Thumb
    • Overvalued: Low ROE + High P/BV Ratio
    • Undervalued: High ROE + Low P/BV Ratio

Applicable to those industries which need to revalue their balance sheet assets every year. Used in valuing Financials, especially banks, which squeeze a small spread from a large base of assets (loans) and multiply that spread by utilizing high levels of leverage (deposits) 

Limitation

Price to Book Value Ratio (P/B Ratio) Video

 

This article has been a guide to Price to Book Value Ratio. Here we discuss the calculation of price to book value ratio along with its formula, how to use it for valuations and limitation. You may also have a look at the following articles –

Reader Interactions

Comments

  1. Tanupreet chadha says

    Hi Dheeraj,

    The article was a quick and informative read. Needless to say, you know to the art of sharing.
    Apart from this i have some concerns regarding financial modelling, which i have completed from my end atleast. My comments are stuck on the relevant page,so posting here. Please follow my email which includes my solved worksheet of colgate and address the queries mentioned.

    Thankyou and looking forward to your response.

    Tanupreet.

    • Dheeraj says

      Hi Tanupreet,

      The sheet that you had sent doesn’t contain any errors. Such errors can be excel /computer specific. You may try again with the following to remove #DIV #Value kind of errors –

      Circular reference comes due to two aspects –
      1. Interest income/interest expense from debt schedule is linked to INcome Statement sheet.
      2. diluted number of shares are linked back to Income Statement.

      For 1 – Try this if this helps – IS SHEET
      a) go to income statement – Copy all range of linked cells L14 to N14 from the debt schedule to let’s say Q14 to S14.
      b) Delete the links L14 to N14 (blank it totally)
      c) Copy Q14 to S14 and Paste it back to L14 to N14.

      if error still persists then try this –

      Go to 2 – Try this if this helps – Shares Outstanding Sheet
      a) Copy all range of linked cells L8 to N8 from the shares outstnading to let’s say Q8 to S8.
      b) Likewise do it for L12 to N12 and copy it to Q12 to S12
      c) Delete the links L8 to N8 & L12 to N12
      d) Copy Q8 to S8 and Paste it back to L8 to N8
      e) Copy Q12 to S12 and Paste it back to L12 to N12

      All the best,
      Dheeraj

  2. PRABHAKAR BV says

    Your articles are always informative.

    You are a financial wizard.

    Keep posting.

    Thanks.

    • Dheeraj says

      Thanks Prabhakar! :-)

  3. shrikant says

    Dhiraj,

    ” The Excellent info. Pl keep posting such knowledgeable info.

    Awaiting for your next mail.

    Regards,

    Shrikant

    • Dheeraj says

      Thanks Shrikant :-)

  4. stefano says

    Great and complete explanation ! Nothing has been left out, great job!

    • Dheeraj says

      Thanks Setefano!

  5. Samuel R. Hill says

    You have a typo in the second sentence copied from above, which I think should be 2014 and not 2015 for the second sentence. Please see below:

    Citigroup Price to book value (PBV) 2015 = $42.83/71.57 = 0.5983x

    Citigroup Price to book value (PBV) 2015 = $42.83/68.174 = 0.6282x

    • Dheeraj says

      Thanks Samuel for this. I corrected the errors as suggested.