Price to book ratio definition
/What is the 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.
How to Calculate the Price to Book Ratio
To calculate the price to book ratio, subtract intangible assets and liabilities from total assets, and then divide the result into the closing price of the stock. The formula is as follows:
Closing price of the stock ÷ (Total assets - Intangible assets - Liabilities)
= Price to book ratio
Related AccountingTools Courses
The Interpretation of Financial Statements
Problems with the Price to Book Ratio
Investors like to use this 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, which include the following:
Ongoing Mismanagement
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.
Use of Accelerated Depreciation
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.
Hidden Intellectual Property
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.
High Asset Valuations
The value of company assets could be higher than what appears on its balance sheet. This is especially common when a firm owns large amounts of real estate.
High Research and Development Expenditures
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.
Few Fixed Assets
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.