Market Terms

Price to Book Ratio (P/B)

What is P/B Ratio?

The P/B Ratio, or Price-to-Book Ratio, is an index used to evaluate a company's value in relation to its book value. It is one of the most popular measures for assessing stocks and is widely used by investors.

What Does It Represent?

The P/B Ratio represents the relationship between the current share price of a stock and the book value of the company. The book value is the value of the company's assets minus the value of its debts.

How to Interpret Its Value?

When the P/B Ratio is less than 1, it generally indicates that the company may be undervalued, as the market value is lower than what it would have in the case of liquidation (selling buildings, materials, inventory, and everything in the company's name). On the other hand, a P/B Ratio greater than 1 may suggest that the company is overvalued.

It's common to have a book value above 1 since the company also consists of assets that cannot be financially quantified. For example, imagine you have the money needed to buy all of Citi Bank's assets, including branches, licenses, patents, etc. Could you create a company of the same relevance? Probably not because we must take into account that it's a well-established and globally recognized financial institution.

Thus, it wouldn't be unusual for this implicit value to be appreciated by the market, causing the company's value to exceed its book value.

Another scenario where this multiple doesn't reflect reality is companies with very low book value but with high profits (as is the case with technology companies).

How Is It Calculated?

The P/B Ratio is calculated by dividing the company's price (market value) by the company's book value. The formula is as follows:

Or on a per-share basis using VPA:

P/B Ratio from Graham's Perspective

Benjamin Graham, one of the most famous investors in history, advocated using the P/B Ratio as a safety measure for investors. Graham believed that buying stocks with a P/B Ratio below 1 was a safe strategy for long-term profit.

According to him, the maximum value to be paid should be 1.5x, and the maximum P/E Ratio should be 15x. As mentioned earlier, this doesn't apply to all companies or all sectors. For comparison, we can use 3M (MMM) as an example, which in 1Q2023 had a P/E Ratio of 10.5x, but its P/B Ratio was 3.67x, 2 times higher than the maximum specified by Graham.

By establishing a historical average for the company, the sector, or simply an average of 1.5x, we can calculate the fair stock price through the Graham's Number Calculation.

Example

C:

Citigroup Inc. is a globally recognized financial institution. At the end of 2022, its book value was $200B, while its market value was $87.6B. Therefore, its P/B Ratio was: Loading...Loading...

In other words, the company's market value represents 44% of its book value, creating a 56% discount or premium. This basically means that for every $1 of the company's book value, the market is paying 44 cents. The average P/B Ratio for the company over the past 10 years is 0.735, which means the company is trading 40% below its average.