P/B Ratio – Explained

P/B ratio stands for price-to-book ratio. The formula to calculate it is,

P/B = Market Price of Share ÷ Book Value per share

Imagine a company ABC and ABC’s assets to be ₹1000. On the other hand ABC also has a loan of ₹450. The Book Value is obtained by subtracting liabilities from assets, so ₹1000 minus ₹450 = ₹550. So the book value becomes ₹550. Also let’s assume ABC has 5 shares. So book value per share becomes ₹550 ÷ ₹5 = ₹110.

Assume the Current Market Price (CMP) of company ABC to be ₹150. Now the P/B ratio of company ABC = 150 ÷ 110 = 1.36

Some investors consider a P/B ratio below 1 to be good as it shows that a company is undervalued. On a broader scale investors consider a P/B value under 3 to be good. However investors need to take into account other factors too before picking a stock. For example, for a software company one of its asset is their workforce, but it is viewed under expenses as salary must be paid. On the other hand manufacturing related industries own land and tools that falls under its asset. Land appreciates in value, the buildings depreciate over time etc. So the value of assets vary based on the industry. A software company may have a bigger P/B ratio over a manufacturing company. But that doesn’t mean that the software company is overvalued. Therefore other factors too must be considered before picking a stock.

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