Price/Book Value Ratio
Price/book value ratio is an investment valuation ratio used by investors or finance providers to compare market value of a company’s shares to its book value (Shareholder Equity). This ratio indicates how much shareholders are contributing/paying for a company’s net assets.
Book value provides an estimated value of a company if it is to be liquidated. It is the value of a company’s assets expressed in the Statement of Financial Position (B/S). It is calculated by subtracting company’s liabilities from its assets (Assets-Liabilities). In simple words it shows what shareholders will get after the company is sold and all its debts are paid off. Low ratio represents a good sign for the company.
The “price to book” or “price/book value ratio” helps investors to compare the market value, or the price they are normally paying per share, to the traditional measure of the firm’s value.
This ratio is best suitable for companies that possess a large number of tangible fixed assets as it does not account for intangible assets. Companies having buildings, factories, machineries, equipments, and other fixed assets can use this ratio to check the exact company position. This ratio is best suited to banks and insurance companies as they have a large number of financial assets.
Price/Book Value Ratio = Stock Price Per Share / Shareholders’ Equity Per Share
Norms and Limits
One of its major limitations is that it does not consider intangible assets like Goodwill which leads to low book value and high artificial price/book ratio. The book value considers original purchase price of an item not the current market price which leads to measurement inaccuracies.
Another limitation is that in case of different accounting methods are used, e.g USGAP and IFRS, it gives different asset values which make the comparison even harder.