Monday, December 04, 2006

Book Value & Price-to-Book Ratio

Price-to-book ratio or P/B ratio, is a ratio used to compare a stock's market value to its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value. Book value is the shareholders' equity (assets minus libilities) divided by the total number of outstanding shares. The calculation is often done using 'per share' values for both price and book.
A lower P/B ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company. As with most ratios, be aware this varies a fair amount by industry. Industries that require higher infrastructure capital (for each dollar of profit) will usually trade at P/B much lower than the P/B of (e.g.) consulting firms.
This ratio also gives some idea of whether you're paying too much for what would be left if the company went bankrupt immediately. For companies in distress the book value is usually calculated without the intangible assets that would have no resale value. In such cases P/B should also be calculated on a 'diluted' basis, because stock options may well vest on sale of the company or change of control or firing of management.

See Also: Value Investing , P/E Ratio , Active Portfolio Management , BV in Stock Market

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