Price to Book Ratio (also called market to book ratio) is a relative valuation statistic which measures the proportion of the current market price of a share of a company’s common stock to the book value per share of the company. Price to book value tells whether investors in general value the company above, at or below the face value of the company’s assets as they appear in its financial reports.
Market value of a share is determined by the average opinion of the investors about the company. Book value on the other hand, is determined using accounting principles. There are a number of factors that are not captured by accounting information, for example, value of a company’s brands, reputation, growth potential, etc. Such factors create divergence between the two figures and make price to book ratio a useful tool for finding investor feeling about a company’s future outlook.
Investors who specialize in buying companies whose current market prices are suppressed place significant emphasis on price to book ratio. They buy companies with low price to book ratio but good return on equity and sell them when the market adjusts its opinion about the company’s true worth. Price to book ratio can also be used to find out how much a company is worth by comparing its book value to the average price to book value of the industry or competitors.
|Price to Book Ratio =||Current Share Price|
|Book Value per Share|
Book value per share can be calculated using the following formula:
|Book Value per Share =||Total Shareholders’ Equity|
|Total Number of Shares Outstanding|
P/B ratio can also be calculated using the following formula:
|Price to Book Ratio =||Current Market Capitalization|
|Total Shareholders’ Equity|
Calculate price to book value for Kellogg Company (NYSE: K) and General Mills Inc. (NYSE: GIS) using the following information.
All figures other than per share values are in million US$.
|Relevant current market price||54||48|
|Total shareholders’ equity||2,419||6,672|
|Number of shares outstanding||362||625|
|Relevant current market price (P)||54||48|
|Total shareholders’ equity (X)||2,419||6,672|
|Number of shares outstanding (Y)||362||625|
|Book value per share (B = X/Y)||6.68||10.68|
|Price to book ratio (P/B)||8.05||4.51|
It tells that investors value $1 of net assets (assets minus liabilities) appearing on Kellogg’s balance sheet almost as dearly as $2 of net assets of General Mills Inc. This must be supported by high return offered by Kellogg evidenced by for example high return on equity. If it is not the case, Kellogg’s stock might be overvalued.
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