Price to Book (P/B) Value Ratio and Equity Valuation

P/B = market price per share / book value per share

  • Book Value per Share = Common Equity / Common Shares Outstanding
  • Common Equity = Total Equity - Preferred Equity

Positives of P/B

  • Book value is usually positive.
  • Many financial services companies trade close to their book values.
  • Book value is less volatile than earnings.
  • Stock return trends can be analyzed within the context of differences in P/B values.

Limitations of P/B

  • Industry differences and asset size differences can create comparability challenges for the P/B ratio metric.
  • Differing accounting practices can create comparability challenges for the P/B ratio metric.
  • P/B is often driven by historical asset values (less depreciation), which may not reflect market value.
  • Book value does not always capture all factors that drive a company's value, such as a unique workforce skill set.

P/B Value for a Constant Growth Company

P0/BV0 = (ROE1 - g) / (rce - g)

For justified P/B ratios:

  • As ROE increases, the P/B ratio increases
  • As rce increases, the P/B ratio decreases

Adjusting Book Value

Common adjustments to book value include:

  • Intangible Assets: When a company overpays for an acquisition, then book value should be reduced by the amount of goodwill recognized.

  • Assets and Liabilities: Book value should be adjusted for assets at historical value (moving them to market value); off balance sheet financing vehicles may also require adjustments to book value.

  • Different Accounting Practices: When comparing companies with different accounting practices, adjustments will need to be made so their P/B ratios are really comparable.