Price to book ratio

The price to book ratio compares the current market price of a company's stock to its aggregate book value. When the ratio is excessively high, it can indicate that a company's shares are over-priced, especially when the ratio is high in comparison to the same calculation for other companies in the same industry. The calculation is:

Closing price of the stock ÷ (Total assets - Intangible assets - Liabilities)

Investors like to use the price to book ratio to search for undervalued companies, and invest in their stock in hopes of having the share price return to a more normal level over time. However, there are a number of issues with the ratio to be aware of, including the following:

  • The ratio could be low because the company has been mismanaged, in which case there can be no expectation that the ratio will improve over time.
  • The ratio could skewed too high because the company is using accelerated depreciation to write down the value of its fixed assets at an accelerated rate.
  • The company may have valuable intellectual property that does not appear on its balance sheet at all, but which is being recognized by investors through a high market price for its stock.
  • The company may be investing a large amount in research and development costs, which must be charged to expense as incurred, rather than capitalized. This tends to result in a comparatively low book value for the business.
  • The ratio is not overly useful when evaluating services firms and technology companies, since these entities have comparatively fewer fixed assets on their balance sheets.

Related Courses

Business Ratios Guidebook 
The Interpretation of Financial Statements