Investment Definitions: The Price-to-Book Ratio

Investment Definitions: The Price-to-Book Ratio

As we continue on our stock market definitions path, we come to the price-to-book ratio. Also known by the terms the price/book ratio, the price/equity ratio and the P/B ratio, this stock ratio tells you if a stock is a good deal or a company is in trouble. Want to know more? Well, let’s take a gander.

Definition, Please

Before we go too far, let’s define the P/B ratio. To determine a stock’s price/book value, we calculate the ratio as a percentage by dividing the most recent quarter’s book value per share into the current stock price. Since the book value per share is the amount listed on the company’s balance sheet, comparing the current stock price can tell us how the company is faring in value.

Reading the Numbers

If the stock value and the company value are in line, the company is pretty much on track. But if the P/B ratio is too low, the company could either be undervalued (and could be an awesome investment opportunity) or the company could be on the verge of breakdown.

Before we get into reading a low price/book ratio, we need to look at one important factor: the industry. As with most ratios, the price/book ratio differs by industry. For example, the norm for a cereal company will be entirely different than the P/B ratio for a technology firm. It is important to know the average P/B ratio for the industry and make sure you compare like-industry stocks.

Determining When a Stock is a Steal

Okay, now onto reading into a low P/B ratio. How can you tell if a low number indicates an undervalued stock and therefore a steal or if it indicates a floundering company? As with most ratios, we must look beyond the ratio at hand. This means that if you come across a low P/B ratio, you’ll have to look at other factors to determine if the company is healthy.

You can take a look at other ratios to see how the company fared in other aspects of business. Or read reports about the company’s outlook and about potential upswings in production. Basically, you’ll most likely benefit if you research the company and make sure that company projections do not look poor.

As with all stock ratios, the price/book value ratio is a great tool to use in conjunction with other ratios and research. It very well could help you land a stock steal.

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femmefrugality's picture

femmefrugality wrote:

Mon, 05/14/2012 - 16:26 Comment #: 1

What is a good ratio? Like, how low would the ratio have to be for me to know it's either breaking down or a steal of an investment?

Christa Palm's picture

Christa Palm wrote:

Mon, 05/14/2012 - 22:31 Comment #: 2

FemmeFrugality, the P/B ratio varies by industry. For example, cereal company P/B values are completely different from auto industry P/B values which differ from technology stocks' P/B ratios (etc., etc. for each industry). You can check out the normal P/B for any industry you're interested in by doing a Google search for "P/B value XYZ industry." Hope that helps!