As we all know, Warrant Buffet and Benjamin Graham are two greatest investors in the world. These two investors are the supporters of value investing. There is no other fundamental analysis metric that is stronger than the price to book ratio.
The Relations between Value Investing and Book Value
Value investors do not give so much concern about earning growth as much as their concern on the company’s intrinsic value. They always try to find that intrinsic value before the other investors on the market.
One of the popular metrics used by popular investors is the price to book (P/B) ratio. This metric analyzes the current value on the market places on the stock, like what is in its stock price relative to a particular company’s book value.
To calculate the price to book value we need the amount of shareholders’ equity on the company’s balance sheet. Or, you can use the following formula to calculate it.
Book Value = Assets – Liabilities
To help you understand the concept of book value, imagine that there is a company that stops operating its business immediately. Then, you liquidate all of their assets and pay all of their debts. Then, the company’s book value is the amount of the remaining money left on that company divided by the number of shareholders.
Calculating the Price to Book Value Ratio
To calculate the price to book value ratio, use the following formula.
Price to Book Ratio = Stock Price / (Assets – Liabilities)
Then, there is a possibility that you find the P/B ratio of a company to be undervalued. The higher P/B ratio shows that the company has overvalued the stock.
If you use this ratio to evaluate the stocks, then you need to consider the P/B ratio of other stocks in the same sector. That is because the baseline of the P/B ratio can be different depending on their sector.
Similar to other fundamental analyses, an independent result from this ratio calculation is open to various interpretations. For instance, if stock market mechanics highly affected the price stocks, then, it can skew the P/B ratio to be irrelevant.
Or else, if a company has a large total assets number, you can also have a skew P/B ratio.
