Business
What is Price-to-Book ratio in stock valuation? How to calculate, use and more queries answered | – Times of India
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Price-to-Book ratio: The Price-to-Book ratio is widely used to evaluate a company’s value. Here, we explore its meaning and how to use it effectively for stock valuation.
What is the PB ratio?
The Price-to-Book ratio is a fundamental metric employed by investors to gauge the valuation of a stock. It offers insights into whether a stock is undervalued or overvalued.
How is Price-to-Book ratio calculated?
The PB ratio is calculated by dividing a stock’s current market price by its book value.The book value represents a company’s total assets minus its total liabilities.
For instance, if a company has assets worth Rs 40 crore and liabilities worth Rs 20 crore, with 10,000 outstanding shares and a stock trading at Rs 200, the book value per share is calculated as (40 crore – 20 crore) / 10,000 = Rs 2000. Then, the PB ratio is determined as 200 / 2000 = 0.1.
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How to use the PB ratio?
The PB ratio is a comparative metric, meaning it’s typically compared with industry peers or historical data. A PB ratio above 1 often suggests that a stock is trading above its book value. Generally, the higher the PB ratio, the more expensive the stock, and vice versa. ET has quoted Karthik Kumar, a fund manager at Axis Mutual Fund as saying that stocks with high PB ratios are often seen as expensive, possibly due to anticipated growth. Conversely, a low PB ratio may indicate an undervalued stock or a challenging business environment.
Interpreting PB ratio in real markets
It’s essential to consider the PB ratio alongside other factors rather than relying solely on it. Christy Mathai, a fund manager at Quantum Mutual Fund, highlights that PB ratio interpretation varies across sectors, such as commodities. In an up cycle, commodity stocks may have lower PB ratios, potentially leading to a misinterpretation of undervaluation. Additionally, the PB ratio can aid in identifying inflection points in valuations. As per Karthik Kumar of Axis Mutual Fund, when a stock’s PB valuations significantly deviate from those of its peers, it’s more likely to revert to the mean.
Integration with Return-on-Equity (ROE)
The PB ratio is often considered alongside Return-on-Equity (ROE) when evaluating a stock. Analysts emphasise this because ROE reflects earnings growth, and the two metrics typically correlate. Mathai was quoted saying, “A high ROE but low PB ratio indicates undervaluation and a low ROE, but high PB ratio indicates overvaluation.”
The PB ratio is most commonly used in sectors with substantial tangible assets. Kumar stated that industries such as transport, commodities, refining, capital goods, and banks find the PB ratio particularly effective for evaluating stock valuation.
Limitations of the PB ratio
While the PB ratio serves as a useful indicator, it has limitations and may not always provide accurate assessments. It’s reliable for sectors with tangible assets but less so for those reliant on intangible assets like R&D or intellectual property, according to Kumar.
Additionally, Mathai notes that the PB ratio is a stable yet slow-moving metric based on equity valuation, which means it may take time to reflect positive changes in a stock’s value.
What is the PB ratio?
The Price-to-Book ratio is a fundamental metric employed by investors to gauge the valuation of a stock. It offers insights into whether a stock is undervalued or overvalued.
How is Price-to-Book ratio calculated?
The PB ratio is calculated by dividing a stock’s current market price by its book value.The book value represents a company’s total assets minus its total liabilities.
For instance, if a company has assets worth Rs 40 crore and liabilities worth Rs 20 crore, with 10,000 outstanding shares and a stock trading at Rs 200, the book value per share is calculated as (40 crore – 20 crore) / 10,000 = Rs 2000. Then, the PB ratio is determined as 200 / 2000 = 0.1.
ALSO READ | Considering investing in debt funds? Know options available, benefits, returns, taxation rules – FAQs answered
How to use the PB ratio?
The PB ratio is a comparative metric, meaning it’s typically compared with industry peers or historical data. A PB ratio above 1 often suggests that a stock is trading above its book value. Generally, the higher the PB ratio, the more expensive the stock, and vice versa. ET has quoted Karthik Kumar, a fund manager at Axis Mutual Fund as saying that stocks with high PB ratios are often seen as expensive, possibly due to anticipated growth. Conversely, a low PB ratio may indicate an undervalued stock or a challenging business environment.
Interpreting PB ratio in real markets
It’s essential to consider the PB ratio alongside other factors rather than relying solely on it. Christy Mathai, a fund manager at Quantum Mutual Fund, highlights that PB ratio interpretation varies across sectors, such as commodities. In an up cycle, commodity stocks may have lower PB ratios, potentially leading to a misinterpretation of undervaluation. Additionally, the PB ratio can aid in identifying inflection points in valuations. As per Karthik Kumar of Axis Mutual Fund, when a stock’s PB valuations significantly deviate from those of its peers, it’s more likely to revert to the mean.
Integration with Return-on-Equity (ROE)
The PB ratio is often considered alongside Return-on-Equity (ROE) when evaluating a stock. Analysts emphasise this because ROE reflects earnings growth, and the two metrics typically correlate. Mathai was quoted saying, “A high ROE but low PB ratio indicates undervaluation and a low ROE, but high PB ratio indicates overvaluation.”
The PB ratio is most commonly used in sectors with substantial tangible assets. Kumar stated that industries such as transport, commodities, refining, capital goods, and banks find the PB ratio particularly effective for evaluating stock valuation.
Limitations of the PB ratio
While the PB ratio serves as a useful indicator, it has limitations and may not always provide accurate assessments. It’s reliable for sectors with tangible assets but less so for those reliant on intangible assets like R&D or intellectual property, according to Kumar.
Additionally, Mathai notes that the PB ratio is a stable yet slow-moving metric based on equity valuation, which means it may take time to reflect positive changes in a stock’s value.
