9. Price to Book Value Ratio (P/BV)
P/BV = Market Price per share / Book Value, where BV = (Equity + Reserves) / Outstanding shares
Price to Book Value Ratio is one of the most widely used ratio to find price relative to the value. The book value is the accounting value per share, in the books of the company. It represents the net-worth (capital plus reserves) per share. An important limitation of this number is that most assets on the books of the company are shown at their historical cost less depreciation and not their realizable/liquidation value. However, in a company which has been building reserves from sustained profitability, the book value is an important indicator of value. Since the book value considers the net-worth of a company, it is an important number in fundamental analysis.
Example:
Equity Capital: – Rs. 5 Lakhs
Reserves & Surplus: Rs. 25 Lakhs
Number of shares outstanding: 3 lakhs
Current Market Price: Rs. 20
Then, BV would be:
Net-worth/ Number of shares outstanding = (Rs. 5 Lakhs + Rs. 25 Lakhs)/ 3 Lakhs = Rs. 10 And, P/ BV would be:
P/BV = CMP/BV = 20/10 = 2x
Hence P/ BV ratio of this company would be 2 times.
How to Analyse:
P/BV less than 1 indicates the company is trading below its book value, and hence the stock is deemed to be undervalued. However, it is pertinent to ask, ‘why is the market pricing the share at a price less than BV?’ Please note that there may be several reasons for a stock being available for less than its book value including the poor investments made by the firm in the past which need to be written down subsequently. Hence, all the companies with P/BV less than 1 may not be value buys. Investors should not rely only on PBV for their investment decisions and should understand that not all stocks that trade at a discount on their book values are bargains (undervalued). PBV is a useful measure to value stocks where the earnings are negative and the more widely used PE ratio is not applicable.
