- Equity Analysis Part 3 - Introduction
- Free Cash Flow Valuation
- One, Two, and Three Stage FCF Calculations
- Share Price Multiple Methods in Equity Valuation
- Price to Earnings (P/E) Ratio (Leading P/E and Trailing P/E)
- Price to Book (P/B) Value Ratio and Equity Valuation
- Price to Sales (P/S) Ratio
- Price to Cash Flow Ratios
- Enterprise Value (EV) to EBITDA
- Dividend Yield for Valuing Equity
- Residual Income (RI) Valuation Model
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.
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