Price to Book Value Ratio is one of the most important ratios used for Relative Valuations. It is usually used along with other valuation tools like PE Ratio, PCF, EV/EBITDA 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.
- What is Price to Book Value?
- Price to Book Value Calculation
- PB Ratio of Software Companies
- Price to Book Value Calculation for Automobile Companies
- Why PB Ratio used in Banking Sector
- Historical Price to Book value vs Forward Price to Book value
- How to use PB Ratio for valuations?
- Relationship between PB Ratio and ROE
- Limitation of Price to Book Value
What is Price to Book Value?
Price to book value is one of the relative valuation tools used to measure stock valuation. 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 Formula = Price Per Share / Book Value Per Share
Please note that Book value = Shareholder’s Equity = Net Worth.
They all are one and the same!
If price to book value 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 formula to calculate Citigroup PB Ratio. First, we require Citigroup’s Balance sheet details. You may download Citigroups 10K report from here.
Below table show the Consolidated Shareholder’s equity section found on Page 133
From the table above, Citigroup’s Shareholder’s 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 Price to book value (PBV) 2014 = $42.83/71.57 = 0.5983x
Citigroup Price to book value (PBV) 2015 = $42.83/68.174 = 0.6282x
Also, note that Assets = Liabilities + Shareholder’s Equity (Simple accounting equation)
Shareholder’s Equity or Book Value = Assets – Liabilities.
If you wish to brush up your accounting basics, you can look at this Free Accounting Tutorial
In case of Citigroup, we could have also used an alternated formula as provided above.
PB Ratio of Software Companies
In this section, we see how PB Ratio of Software companies is calculated, whether it makes sense for us to apply PB 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
Key Observation of Microsoft Balance Sheet (in context of Book Value)
- Microsoft has high amount of Cash and Cash Equivalents
- Microsoft Property plant and equipment is less than 10% of the total assets
- Its inventory is low as compared to Asset Size
- Goodwill and Intangible Assets are greater than the Tangible Assets
With a general understanding of Software companies balance sheet, let us now look at the Historical PB Ratio of some of the Internet/Software companies.
Below graph shows a quick comparison of Historical Book values of Microsoft, Google, Citrix and Facebook.
source: Ycharts
Key Observations
- It can be noted that PB ratio (Price to Book) is generally higher for software companies. We note that for above companies price to book value is higher than 4-5x.
- Primary reason for higher Price to Book Ratio is low tangible assets as compared to the total assets.
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- Value derived from above may not the be correct number to look at.nternet and software companies have higher amount of intangible assets and therefore the Book
(as seen in the Microsoft Balance Sheet)
- Please note that due to this reason we do not use Price to Book Value as a valuation ratio for companies that have low amount of tangible assets .
- Additionally, these companies are high growth companies in most cases, where we can apply alternate measure like PE ratio or PEG ratio to incorporate growth during valuations.
Other sectors where you will find higher Price to Book value and CANNOT apply PB Ratio
- Internet Companies like Amazon, JD.com, Google, Alibaba, Ebay
- FMCG Companies like Colgate, P&G, Walmart, Cadbury, Coca-cola
Price to Book Value Calculation for Automobile Companies
As noted above that PB 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 of General Motors.
You can download General Motors 10K report from here.
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 Price to Book value as a valuation proxy.
Below graph shows a quick comparison of of Historical Book values of General Motors, Ford, Toyota Motors and Nissan.
source: Ycharts
Key Highlights of Price to book value of Automobile Companies
Automobile companies generally have a Price to Book value of greater than 1.0x.
This normally happens because their asset book value tend to underestimate their replacement value
Even though we can apply PB Ratio as a proxy for automobile companies valuation, it is still note the primary valuation tool for such capital intensive sectors. However, you may find some analyst taking this into consideration in the comparable 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 PB Ratio or Price to Book value used in Banking
From above, we have note that PB ratios cannot be applied to Internet and software companies, however, we can still use these ratios as a proxy for capital intensive 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.
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 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.
Below graph shows a quick comparison of of Historical Book values of JPMorgan, UBS, Citigroup and Morgan Stanley.
source: Ycharts
Why Price to Book Value can be used to value Banking Stocks
- Since Banking Assets and Liabilities are periodically marked to market, their assets and liabilities represent the fair or the market value. Hence, PB Ratio can be used for valuing Banking Stocks.
- Under ideal conditions, the price/book value (P/BV) ratio should be close to 1, though it would not be surprising to find a P/BV ratio of less than one for a bank with large amount of Non Performing assets.
- It is also possible to find a P/BV ratio above 1 for a bank with significant growth opportunities due to, say, its location, because it is a desirable merger candidate, or because its use of technology in banking.
Historical Price to Book value vs Forward Price to Book value
Like the Trailing PE and the Forward PE, we can have the similar formula for Price to Book Value.
Historical Price to Book Value = Current Price / Book Value (historical)
Forward Price to Book Value = Current Price / Book Value (Forward, forecast)
Price to book value of historical is relatively straight forward 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 –
- 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 consensus book to value forecast
- 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 Free Financial modeling Training.
Let us take an example to see how we can incorporate Trailing and Forward Price to Book Value to identify the cheapest and most expensive stock from the consideration set.
Calculate the historical PB and Forward PB
AAA Bank, Historical Book Value is $500.0 and its Current Market Price is $234.
Trailing PB Ratio = $234 / $500 = 0.5x
Likewise, we can calculate Forward Price to Book Value of AAA Bank. AAA 2016 estimated Book Value is $400.0 and its current price is $234.
Forward PB Ratio = $234 / $400 = $0.6x
Some of the things to consider regarding the Historical and Forward Price to Book Value
- If Book Value is expected to increase, then the Forward PB Ratio will be lower than the Historical Ratios. We can observe this in 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 future, then you will note that the Forward PB Ratio will be higher than the Historical PB 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 PB 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 PB Ratio and Forward PB Ratio.
Which is the cheapest bank?
- The cheapest Bank from the table provided is AAA Bank. Its Historical Price to Book Value 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 forward PB Ratio may increase further. The delincing 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 PB 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 experience losses each year, thereby leading to 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 reasons above.
Relationship between PB Ratio and ROE
Price to book value is closely related to ROE of the company.
(Price/Book Value Per share) = (Price/EPS) x (EPS/Book Value Per share)
Now, Price/EPS is nothing but PE ratio.
EPS/Book value per share 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
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General Rule of Thumb
- Overvalued: Low ROE + High P/BV
- Undervalued: High ROE + Low P/BV
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 of Price to Book Value
- Book value only takes into consideration the tangible value of the firm. Intangible economic assets like human capital is not taken into account in PB Ratio.
- Effect of technology upgrades, Intellectual Property, Inflation etccan cause the book and market values of assets to differ significantly
- Accounting Policies adopted by the management can have significant impact on the Book Value. For example, Straight line method vs Accelerated deprecation method can change the Net Property Plant and equipment value drastically.
- Additionally, Business model can also lead to differences in Book Value. A company that outsources production will have lower book value of assets as compared to a company that produces goods in-house.
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