Another popular valuation tool useful for investor is the Price-to-Book (P/B) ratio. It is used to determine whether a stock is overvalued, undervalued or fairly valued, similar to the Price-to-Earnings (P/E) ratio.
The book value of an asset measures the net asset value of the company and is typically adjusted to derive a net tangible asset value (book value less intangible and goodwill). The P/B ratio measures how much the market is willing to pay for a dollar of a company’s net tangible assets per share. It can be more appropriately used for companies which primarily hold key valuable assets. Some of these companies include banks, investment holding firms, insurance companies and property companies. Since book value is cumulative amount and usually positive, it is more stable as compared to earnings which can be volatile in nature.
The P/B ratio does not reflect intangible economic assets such as human capital and could be misleading in some cases if a company outsources more of its production. This leads to a lower asset base, resulting in a lower book value and a higher P/B ratio as compared to a similar company which does not outsource its productions.
Some examples in which the P/B ratio might be applicable could be City Development (SGX: C09.SI) and Haw Par (SGX: H02). Companies such as Biosensors International (SGX: B20)which has a 50.8% (as of March-2014)of its total assets as goodwill & intangibles or technology companies such as Facebook (NASDAQ: FB) or Google (NASDAQ: GOOG) might have less application for the P/B ratio. Such companies tend to have the bulk of their assets in patents, goodwill as a result of acquisitions and other intellectual property.
Value in Action
The P/B ratio is useful in valuing companies which have marketable and liquid assets. It can also be used to value companies on a liquidating basis. Moreover, the book value tends to be relatively stable and is a cumulative amount, which implies that P/B is usually positive, as compared to earnings which can have losses, rendering the P/E ratio useless.
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The information provided is for general information purposes only and is not intended to be any investment or financial advice. All views and opinions articulated in the article were expressed in Willie’s personal capacity and do not in any way represent those of his employer and other related entities. Willie doesn’t own shares in any companies mentioned above.