How to Use Price to Book Value (PB Ratio) for Stock Analysis?

Created : May 08, 2021 Author : Deepika Khude Category : Samco account help & support, Basics of stock market, Everything about Investing

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Warren Buffett is the sixth richest man in the world. His net worth is a whopping US $100.6 Billion! That’s roughly Rs 74,27,85,13,00,000. Do you know what’s more shocking? It’s that a majority of this net worth is from the stock markets. One would think he has a magic stone or a genie in a bottle. But no. The secret to his wealth is a simple two-letter word – Value Investing. Value Investing is buying undervalued shares and holding them for a long time. The idea is to make humongous profits once markets realise their true value. [Recommended Read: Best Value Stocks to Buy in India in 2021] Sounds simple, doesn’t it? Just buy some undervalued shares. But how do you know if a share is undervalued, overvalued or fairly priced? Price to Book Value is a type of valuation ratio which calculates a stock’s intrinsic value. It helps you understand if a stock is undervalued, overvalued or fairly priced. Price to Book Value is also known as Market to Book Ratio or Price to Equity Ratio or simply P/B (PB) ratio. It is an important cornerstone of value investing. It helps you find out whether you are buying a stock at a discount or premium. In this article we will explore everything about Price to Book Value including:

1. What is Price to Book Value? 2. How to Calculate Price to Book Value? 3. What is the Ideal Price to Book Value? 4. How to use Price to Book Value to analyse stocks? 5.What is the Price to Book Value of Sensex Stocks?

As a bonus, I will also share a list of high price to book value and low price to book value stocks. But first, exactly what is Price to Book Value?

What is Price to Book Value?

Price to Book Value is a financial ratio that compares a company’s stock price with its net assets. Net assets is total assets minus total liabilities. PB Ratio is the amount investors are willing to pay for a share in the company’s assets. It is also the amount an investor gets (per share basis) if the company goes bankrupt. It tells you whether a stock is overvalued or undervalued. Why is finding undervalued stocks important? Because historically, undervalued stocks have outperformed stocks with high PB ratio. Investing legends have made their fortune by investing in undervalued stocks. And most importantly, everybody loves a good bargain. PB ratio is a tool to figure out which stocks are trading at a discount.

How to Calculate Price to Book Value?

There are two formulas to calculate price to book value. Both formulas provide the same answer.

Price to Book Value = Market Capitalisation / Book Value of Assets
Price to Book Value = Current Market Price / Book Value per Share

Current market price is readily available on Samco Stock Rating. Whereas book value per share needs to be calculated. Book Value is equal to net assets of the company. This is the amount the shareholders will get if the company goes bankrupt.

Book Value Formula = (Total Assets – Liabilities – Intangible Assets) / Number of outstanding shares.

[Read More: What are Outstanding Shares] Intangible assets like patents, intellectual property, goodwill etc are not included while calculating a company’s book value. Only appreciating hard assets like cash, land, gold, plant and machinery etc. are considered.

Price to Book Value Example

Let us calculate the price to book value (PB) ratio for Reliance Industries Ltd.

Current Share Price = Rs 1,959
Total Assets = Rs 13,21,212 (crores)
Total Liabilities = Rs 6,21,040 (crores)
Outstanding Shares = 634 (crores)

Step 1: Calculate book value per share. Book Value per Share Formula = Total Assets – Liabilities / No of Outstanding Shares = (Rs 13,21,212 – Rs 6,21,040) / 634 = Rs 1,104 What does a book value of Rs 1,104 mean? It means that investors will get Rs 1,104 after paying Rs 1,959 (as share price) in case Reliance Industries goes bankrupt. Step 2: Price to Book value is calculated by dividing a stock’s current market price by book value per share. Price to Book Ratio = Current market price / book value per share = Rs 1,959 / Rs 1,104 = 1.77 This means that investors are paying 1.77 rupees for one rupee of Reliance Industries assets. So, is this a good PB ratio? Let’s find out.

What is the Ideal Price to Book Value?

Like most financial ratios, even PB ratio differs across industries. But the ideal price to book value is less than or equal to 1. This signals an undervalued company. However, price to book value up to 3 is also acceptable. High price to book value companies are overvalued and do not fit the value investing criteria. Price to book value can also be negative. The main cause behind a negative PB ratio is consistently negative cash flow. Another reason is when total loss wipes off shareholders equity capital. However, industry and peer comparison are a better approach to understanding the ideal price to book value. For example: The PB ratio of Kotak Mahindra Bank Ltd is 5.09. PB ratio of Axis Bank Ltd. 2.49. Industry PB ratio of private banks is 1.83. In this case, Axis Bank is undervalued in comparison to Kotak Mahindra Bank. But low price to book value should be accompanied by high return on equity (ROE). Only then you can conclude that the stock is truly undervalued. This brings us to an important disclaimer about Price to Book Value. You cannot use PB ratio for all sectors. In fact, it’s pretty useless in industries like Information & Technology (IT). Why? Let’s explore the limitations of PB ratio.

When Should you NOT use Price to Book Value?

Analysing IT or Service Industry: PB ratio only considers tangible assets. But IT companies have very little tangible assets. Instead they have high intangible assets. These include patents for a software or a coding program etc. When tangible assets are less, PB ratio automatically increases.

This signals an overpriced stock. However, this is a wrong signal. Price to book value of Google’s parent company Alphabet is 6.98. This is way above our ideal PB ratio of 3. So, does it mean you shouldn’t invest in one of the biggest companies on the planet?! Absolutely Not! Similarly, PB ratio of Tata Consultancy Ltd (TCS) is 13. This is way above the industry PB ratio of 7.09. However, TCS is a 5-star rated stock with a healthy 8.61% sales growth. [Check out: Samco’s Stock Rating for TCS Ltd] Hence Price to book value should be avoided in case of IT and service industries. 2. High Debt Companies: This is again an artificial way to increase PB ratio. However, this is a blessing in disguise. Because it is anyways recommended to avoid high debt companies. However, there is one exception here. You can invest in a high debt company only if its interest coverage ratio is also high. For example: Chennai Petroleum Corporation Ltd (CPCL) has a debt to equity ratio (DE) of 5.38. This is very high. It’s PB ratio is 1.06. The industry PB is 1.49. You would think that this company is undervalued. But look at its high debt! This is one of the reasons why CPCL is a 0.5 star rated stock and should be avoided! 3. High Depreciating Assets: On a balance sheet, a company’s assets are quoted at their cost price. But this keeps on changing due to wear and tear. Companies often over or underestimate asset’s market price which shows an incorrect PB ratio. This is common in steel or cement industries. In such situations, a deeper look at DE ratio and Price-to-Earnings ratio is recommended. [Read More: How to Read Balance Sheet of a Company] 4. Capital Intensive Sectors: Investors should use price to book value in capital intensive sectors only. This includes transport, telecommunication, refining etc. These companies have high tangible assets. Hence it is important to understand your claim on these assets when you invest in a company. But again, it is important to compare this with the industry PB ratio to arrive at the correct conclusion. Below is the price to book value of refining sector companies.

Refining Companies	Price to Book Value	Industry PB Ratio
Bharat Petroleum Corporation Ltd	2.25	1.45
Hindustan Petroleum Corporation Ltd	0.99	1.45
Chennai Petroleum Corporation Ltd	1.00	1.45
Mangalore Refinery and Petrochemicals Ltd	1.23	1.45

Looking at PB ratio, we can conclude that Bharat Petroleum Corporation Ltd is overvalued in the refining sector. This is one of the reasons why it is a 1-star rated stock! Now, you must be thinking – ‘If low price to book ratio means an undervalued stock, then are all low price to book value stocks wealth creators?’ Sadly No! Here’s proof…Below is the list of 10 stocks with lowest price to book value. Look at their return on equity!

Low Price to Book Value Stocks	Return on Equity (%)	Price to Book Value
Diamond Power	-164.65	0.03
Unitech International Ltd	-22.77	0.08
Mcleod Russel India Ltd	-9.79	0.13
Eros International Media Ltd	-73.6	0.17
RCI Industries & Technologies	-79.19	0.18
Sintex Plastics Technology Ltd	-44.53	0.19
Reliance Home Finance Ltd	-22.65	0.19

Typically, a high Price to book value is acceptable only if it is supported by a healthy ROE ratio. This brings us to the relationship between price to book value and ROE.

Price to Book Value and Return on Equity (ROE)

ROE measures a company’s ability to generate return on its assets. Ideally ROE should be in line with price to book value. An abnormal deviation can be a potential red flag for investors. Here are some companies with abnormally high price to book ratio but low ROE. These kinds of companies should be avoided at all costs!

Name	Market Capitalisation	Return on Equity	Debt to Equity	Price to Book Value	Industry PBV
Interglobe Aviation Ltd	64,136	-13.99	13.91	35.14	13.03
Trent Ltd	27,836	-6.18	0	12.03	0.87
Aditya Birla Fashion & Retail	16,503	-9.19	5.15	15.02	0.53
Hindustan Copper Ltd	14,970	-43.84	1.47	14.93	1.19
Blue Dart Express Ltd	12,741	0.29	2.66	31.28	12.92

Notice three things in the above table:

All these stocks have negative ROE. This means the management is incurring loss on its assets.
Even after a negative ROE, their price to book ratio is very high compared to industry PBV. This means despite losses; investors are still paying 35.14 rupees for one rupee of assets.
The difference between the company’s PB ratio and industry PB ratio is truly shocking!

Hence it is important to look at PB ratio from the lens of ROE. Let us quickly look at the price to book value of Sensex stocks.

Price to Book Value of 30 Sensex Stocks

The below table shows the price to book value of 30 sensex stocks.

Sensex Stocks	Price to Book Value Ratio	Industry Price to Book Ratio	Return on Equity
NESTLE INDIA LTD.	78.80	37.7	106.00%
TATA CONSULTANCY SERVICES LTD.	13.00	7.09	39.10%
HINDUSTAN UNILEVER LTD.	11.9	22.3	29.20%
ASIAN PAINTS LTD.	22.5	9.62	27.50%
INFOSYS LTD.	7.55	7.09	27.20%
ITC LTD.	4.19	3.14	24.80%
HCL TECHNOLOGIES LTD.	4.11	7.09	20.00%
BAJAJ AUTO LTD.	4.09	4.29	19.80%
TECH MAHINDRA LTD.	3.73	7.09	19.00%
HDFC BANK LTD.	4.42	1.83	18.00%
HOUSING DEVELOPMENT FINANCE CORP. LTD.	3.03	1.34	18.00%
POWER GRID CORPORATION OF INDIA LTD.	1.71	0.80	17.20%
ULTRATECH CEMENT LTD.	4.50	2.52	17.20%
ICICI BANK LTD.	3.36	1.83	15.00%
KOTAK MAHINDRA BANK LTD.	5.09	1.83	14.90%
LARSEN & TOUBRO LTD.	2.61	1.06	14.60%
TITAN COMPANY LTD.	16.9	1.03	13.70%
BAJAJ FINSERV LTD.	4.90	0.76	13.30%
BAJAJ FINANCE LTD.	9.08	0.76	12.80%
SUN PHARMACEUTICAL INDUSTRIES LTD.	3.51	3.06	9.06%
NTPC LTD.	0.83	0.80	8.82%
MARUTI SUZUKI INDIA LTD.	3.80	3.07	8.61%
INDUSIND BANK LTD.	2.07	1.83	8.60%
AXIS BANK LTD.	2.49	1.83	8.33%
RELIANCE INDUSTRIES LTD.	1.77	1.45	7.66%
OIL AND NATURAL GAS CORPORATION LTD.	0.65	0.96	7.13%
STATE BANK OF INDIA	1.25	0.48	6.79%
TATA STEEL LTD.	1.96	1.44	2.26%
MAHINDRA & MAHINDRA LTD.	2.34	3.07	0.32%
BHARTI AIRTEL LTD.	5.17	1.45	-43.30%

Remember, don’t conclude that the State Bank of India is a better stock simply because it has a lower price to book value. Your comparison should be as per industry PB ratio. For your ease, below is the industry price to book value of top sectors as of March 2021.

Industry/Sector	Industry Price to Book Value
Banks – Private Sector	1.83
Banks – Public Sector	0.48
IT Consulting & Software	7.09
2/3 Wheelers	4.29
Cars & Utility Vehicles	3.07
Construction & Engineering	1.06
Cement & Cement Products	4.50
Packaged Foods	37.7
Personal Products	22.3
Cigarettes & Tobacco Products	3.14
Electric Utilities	0.80
Housing Finance	1.34
Pharmaceuticals	3.06
Telecom	1.45
Integrated Oil & Gas	1.45

As promised, here’s the list of best undervalued stocks to invest in 2021. So, the next time you analyse stocks, pay special attention to price to book value. Like Warren Buffett, if you too want to create wealth, then look no further. Simply open a FREE Samco Demat account and welcome to the world of infinite wealth!

FAQs on Price to Book Value (PB Ratio)

What is Price to book ratio?

Price to book value ratio is a popular valuation ratio. It compares a company’s market price to the book value of its assets. High growth companies generally have a price to book value of more than 1. PB ratio is an integral part of value investing. It helps you know if a company is undervalued, overvalued or fairly priced compared to the book value of its assets.

What is a good price to book value?

A good price to book value is less than 1. It signals a solid undervalued company. However, a price to value of less than 3 is also accepted among value investors.

What is book value?

Book value is the net value of a company’s assets after paying off all liabilities. If a company sells all its assets and pays off all its liabilities, then what remains is its book value.

How do you calculate price to book value?

The Price to book value formula = market price of the share/book value per share. To calculate price to book value, you simply divide a company’s share price with its book value. The formula of to calculate book value = (Total assets – liabilities) / number of outstanding shares.

What does a high price to book value mean?

A high price to book value means the stock is overvalued. For example: a company’s PB ratio is 5. This means investors are paying five times for a company’s assets.

What if book value is negative?

Price to book value becomes negative when a company’s liabilities are more than its assets. PB ratio can also be negative due to consistently negative cash flows.

What is a good PB ratio for stocks?

A PB ratio of 1 is a good PB ratio for stocks. However, PB ratio up to 3 is acceptable.

How to use PB ratio to discover an overvalued stock?

Overvalued stocks will generally have a combination of low return on equity and high price to book ratio.

What is the difference between PB and PE?

PB ratio compares a company’s stock price with the book value of its assets. Whereas PE ratio compares a company’s share price with its long-term earnings potential. Both PE and PB ratios are valuation ratios and help investors evaluate whether a stock is undervalued or overvalued.

Is book value a good indicator?

Yes, book value is a good indicator of a company’s valuation. When investors invest in a company, they are owners of its assets. Investors should be aware of what they will get in case the company goes bankrupt. It helps investors value the company and their investment.