Trillionaire Term of the Day - January 16, 2009

Price to Book Ratio 

A Price to Book (P/B) Ratio is a great way to measure the underlying value of a company.  The ratio compares the stock price to the book value per share.  To find book value, simply look on a company’s balance sheet and it is the total assets minus the total liabilities.  Thus, book value per share is the book value divided by the total number of shares available to the public (yahoo finance does the calculations of the ratio for you…don’t worry). So, the P/B ratio is:

Share Price

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Book Value Per Share

How can we use the P/B ratio to help us become better investors and make some money? You must first understand that this measurement looks at the value the market places on the book value of a company.  So, investors look for companies with low P/B ratios, as a low ratio indicates that the stock price is relatively cheap compared to the book value per share.  If two stocks were trading at the same price, the one with a lower P/B ratio would be the one that had more assets on its balance sheet (higher denominator).  To many investors, this low P/B ratio shows that the company they are looking at has more intrinsic value than another company, as the low P/B ratio indicates that the company has more assets under its name.

Let’s do a simple example.  If company A and B are trading at $10 and company A has a book value per share of $5 and company B has a book value per share of $10, what would be more intriguing for value investors looking for company’s with low P/B ratios?  In this example, company A has a P/B ratio of 2, while company B has a P/B ratio of 1.  Thus, company B seems to have a more appealing stock price, as both of them are trading at $10, but company B has a much higher book value per share (thus, it has a lower P/B ratio). 

Let’s check out a real world example.  Exxon Mobil (XOM) is currently trading at $78.10 and has a book value per share of 24.63, translating into a P/B ratio of 3.11.  XOM’s competitor, Chevron (CVX) is currently trading at $71.74 and has a book value per share of 42.80, translating into a P/B ratio of 1.65.  So, if an investor was strictly buying on P/B ratios, CVX would seem like a much better buy than XOM, due to CVX’s much smaller P/B ratio. 

But, P/B should not be the only thing that you check before investing in a company.  You must take into account a bunch of other ratios and factors before deciding to invest.  P/B ratios serve as a great initial screen, though, to find companies that might potentially be undervalued.  

Niki Pezeshki

College Trillionaire