Price-to-Book | TimeValuePrep

Lesson

The price-to-book (P/B) ratio is a financial valuation metric that compares a company's market price to its book value. It is calculated by dividing the market price per share by the book value per share. The P/B ratio determines if a stock is undervalued or overvalued, with a lower ratio indicating that the stock may be undervalued and a higher ratio indicating that it may be overvalued.

Practice Question #1

What is the formula for calculating the price-to-book (P/B) ratio?

A) Market Price / Book Value

B) Market Price per Share / Book Value per Share

C) Book Value / Market Price

D) Book Value per Share / Market Price per Share

Select an option above to see an explanation here.

A) This formula does not account for the number of outstanding shares. B) The correct formula for calculating the P/B ratio is Market Price per Share / Book Value per Share. C) This formula is the inverse of the P/B ratio. D) This formula is the inverse of the P/B ratio per share.

Terms

Price-to-Book (P/B) Ratio:: A financial valuation metric that compares a company's market price to its book value.
Book Value:: The net asset value of a company, calculated as total assets minus intangible assets and liabilities.
Book Value per Share:: A company's book value divided by the number of outstanding shares.

Practice Question #2

Which of the following statements is true regarding the price-to-book (P/B) ratio?

A) A higher P/B ratio indicates that a stock is undervalued.

B) A lower P/B ratio indicates that a stock is overvalued.

C) A higher P/B ratio indicates that a stock is overvalued.

D) The P/B ratio is not useful for determining the value of a stock.

Select an option above to see an explanation here.

A) A higher P/B ratio indicates that a stock is overvalued, not undervalued. B) A lower P/B ratio indicates that a stock is undervalued, not overvalued. C) A higher P/B ratio indicates that a stock is overvalued, as investors are paying more for the company's book value. D) The P/B ratio is a useful valuation metric for determining if a stock is undervalued or overvalued.

Do Not Confuse With

Price-to-Earnings (P/E) Ratio:: A valuation ratio that compares a company's market price to its earnings per share.

Practice Question #3

Company XYZ has a market price per share of $40 and a book value per share of $20. What is the Price-to-Book ratio?

A) 0.5

B) 1

C) 2

D) 4

Select an option above to see an explanation here.

A) 0.5: Incorrect, as $40 / $20 = 2. B) 1: Incorrect, as $40 / $20 = 2. C) 2: Correct, as $40 / $20 = 2. D) 4: Incorrect, as $40 / $20 = 2.

Historical Example

Warren Buffett uses the price-to-book value ratio as a valuation metric to assess the attractiveness of a company's stock. He generally prefers companies with lower price-to-book value ratios, indicating that the market price of the stock is relatively low compared to its book value.

Practice Question #4

Become a Pro Member to see more questions

Example Series 65 Example Practice Question

Real-World Example

A company with a market price per share of $50 and a book value per share of $25 would have a P/B ratio of 2. This indicates that the stock may be overvalued, as investors are paying twice the book value for each share.

Practice Question #5

Become a Pro Member to see more questions

Example Series 65 Example Practice Question

Formulas to Remember

Price-to-Book (P/B) Ratio = Market Price per Share / Book Value per Share

Practice Question #6

Become a Pro Member to see more questions

Example Series 65 Example Practice Question

Formula Examples

Company ABC has a market price per share of $50 and a book value per share of $25. Price-to-Book (P/B) Ratio = Market Price per Share / Book Value per Share P/B Ratio = $50 / $25 P/B Ratio = 2

Pitfalls to Remember

High-growth companies:: P/B ratio may not be as useful for high-growth companies, as their book value may not accurately reflect their future earnings potential.
Intangible assets:: Companies with significant intangible assets, such as intellectual property or brand value, may have a lower book value than their actual worth, leading to a higher P/B ratio.

Mark this subject as reviewed