Market/Book Ratio


Price/Book Ratio

The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market price to its book value. The calculation can be performed in two ways, but the result should be the same either way.

In the first way, the company's market capitalization can be divided by its total book value on its balance sheet.

  • Market Capitalization / Total Book Value


The second method, using per-share values, is to divide the company's current share price by its book value per share (i.e., its book value divided by the number of outstanding shares).

  • Share price / Book value per share


As with most ratios, it varies a fair amount by industry. Industries that require more infrastructure capital (for each dollar of profit) will usually trade at P/B ratios much lower than, for example, consulting firms. P/B ratios are commonly used to compare banks because most banks' assets and liabilities are constantly valued at market values.

A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal (and/or that the market value of the firm's assets is significantly higher than their accounting value). However, P/B ratios do not directly provide any information on the firm's ability to generate profits or cash for shareholders.

This ratio also shows whether an investor is paying too much for what would be left if the company went bankrupt immediately. For distressed companies, the book value is usually calculated without the intangible assets that would have no resale value. In such cases, P/B should also be calculated on a "diluted" basis because stock options may well vest on the sale of the company, change of control, or management firing.

It is also known as the market-to-book ratio and the price-to-equity ratio (which should not be confused with the price-to-earnings ratio), and its inverse is called the book-to-market ratio.


Total Book Value vs Tangible Book Value

Technically, P/B can be calculated either including or excluding intangible assets and goodwill. When intangible assets and goodwill are excluded, the ratio is often specified to be "price to tangible book value" or "price to tangible book."

Key Points

  • The calculation can be performed in two ways: 1. the company's market capitalization can be divided by the company's total book value from its balance sheet, 2. using per-share values, is to divide the company's current share price by the book value per share.

  • A higher P/B ratio implies that investors expect management to create more value from a given set of assets, all else equal.

  • Technically, P/B can be calculated either including or excluding intangible assets and goodwill.

Term

  • Outstanding Shares – Shares outstanding are all the shares of a corporation that have been authorized, issued and purchased by investors and are held by them.

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