• HDFC securities
• 20 Jan 2023
• Knowledge Centre

While purchasing something, we would always want to know if the money that is being paid is worth the value that is being offered. Knowing the value of something can help one avoid purchasing something that is overvalued while also helping them identify things that are undervalued. Investors can do the same while purchasing stocks. This is made possible with the help of the price-to-book ratio.

What is the Price to Book ratio?

The price-to-book ratio, also known as the P/B ratio, is an important financial metric used to analyze any company. This ratio is useful in identifying the total value of the outstanding shares in relation to the book value of the company’s equity.

In simpler terms, the P/B ratio shows the relationship between the current market value of the share and the book value of the company’s equity. The book value of equity is nothing but the value of a company’s assets on the balance sheet of the company. The book value is obtained by finding the difference between the assets and liabilities of a company.

How is the Price-to-Book ratio calculated?

The P/B ratio is calculated by dividing the total market capitalization of a company by the book value of the assets.

Price to Book ratio = Total Market Capitalization / Book value of assets

OR

Price to Book ratio = Market price per share / Book value of assets per share

We can calculate the total market capitalization with the following formula:

Total Market Capitalization = Current market value of a stock X Total number of outstanding shares

Similarly, the formula for calculating the book value of assets is given below:

Book value of assets = Total assets – Total liabilities

Let’s see how the P/B ratio is calculated with an example.

Company ABC’s shares trade at Rs 500 and there are a total of 100 outstanding shares. The total book value of assets is Rs 1,00,000

Total Market Capitalization = 500 x 100

= Rs 50,000

PB Ratio = 50,000 / 1,00,000

= 0.5

Therefore, the P/B ratio of Company ABC is 0.5.

Importance of the P/B ratio

The P/B ratio in share market is a very important ratio because it can help investors identify stocks that are undervalued or overvalued. When the P/B ratio of a company is higher than 1, it means that the company is trading at a premium and might be overvalued. P/B ratio of under 1 signifies that a company might be fairly valued or undervalued. Although an investor should note that a ‘good P/B ratio’ varies from industry to industry.

This ratio is useful in evaluating the overall financial health of a company. Investors that take a value approach towards investing aim to invest in stocks that are fairly valued. With the help of the P/B ratio, it is easy to identify the value of the stock in relation to its assets. Moreover, the P/B ratio can be used as a metric to compare other companies in the same industry.