Price/Book Ratio positive, concepts, around, having, whole

Spongebob

In the FSA book there is a section that lists the disadvantages of the Price/Book ratio. I'm having a hard time wrapping my mind around the whole concept Price/Book in general. Does anyone have a good understanding of these concepts, both negative and positive?

draz

The advantages of P/B ratio over, say P/E ratio should not be hard to understand.

For example, Book is less liable to fluctuations compared to Earnings. How do you interpret the P/E ratio if earnings are 0 or negative?

NC

kd26gioi

The advantages and disadvantages of P/B and P/E are discussed at length in one of the Equity Readings- Introduction to Price Multiples. Try going through that first, and you might understand book value better.

Where do you see it in the FSA book?

shootingstar

P/B is just an easy way of showing a GENERAL valuation. For a company with a P/B of 1.5, all that is saying is that you are paying one and a half times the book value (value of all assets at historical cost and as audited by accountants, minus all liabilities, debt, preferred stock, etc.) for the stock (equity). There are assets that are not necessarily held at historical cost or purchase price, but that doesn't effect the idea behind P/B. If another company, same business model/industry etc. is trading at .65 P/B, in theory the .65 P/B company is relatively undervalued, assuming the company at 1.5 P/B is correctly valued. Hope that makes sense in general.

The main disadvantage of P/B is that it is very basic and broad. Take Google, or Coca-Cola, as an example. Both have relatively large P/B ratios. Does that mean they are overvalued? Not necessarily. The value of Google's computer codes/algorithms/etc., are intangible, and no accountant would ever OK assinging a value to them and classifying them as assets on the balance sheet. But they still have value. Googles P/B is around 4.5 or 4.6, and their market cap is $170B. So, their accounting book value (assets-liabilities) is roughly $40B (170B/4.6). The $130B in extra value that the market prices in is the markets' estimate of intangible asset values and PV of future cash flows. Coke is the similar, in that the value of their formula/marketing/brand is not a tangible asset, and left off of the balance sheet. The market recognizes that it has a lot of value though. Growth companies and companies that have a lot of intangible assets tend to have high P/B ratios. Toyota has a P/B around 1 now, partly because their assets are easily valued, and partly because their intangible brand has taken a hit recently. Companies with P/B below 1, may have assets worth less than their book value(outdated clothing inventory, inventory of Crocs, etc) or liabilities that are off balance sheet (leases, pensions, lawsuits pending, etc.) and the market prices that in.

Overall, any ratio that takes a market price of equity, and compares it to a static accounting value is going to have downsides. Generally though, they are a quick way to compare stocks with basic balance sheets.

Hope this helps a bit. Like all finance ideas, it's opaque and ambiguous.

sdada

Basically, Price to book is the market price of the stock, (e.g., $3.65 for Citi (C) divided by book value, (net equity on the B/s), divided by shares outstanding If net equity is 10 mil and shares outstanding is 5 million, book value per share is $2.00 (10MM/5MM) so P/b is 3.65/2.00 or 1.82 I think this concept is in the equity section. Let me know if this helps.

btcapital

Thank you all for the great advice. The entire concept makes a lot more sense to me now. And yes, beatthecfa, I made an error listing the concept in FSA - I looked it up in the Equity Readings.