Price to Book Ratio Explained (P/B) | Finance In 5 Minutes!

Summary

The video script introduces the Price to Book (P/B) Ratio, a financial metric that compares a company's stock price to its net asset value. It explains the concept of book value, which represents the tangible assets minus liabilities, and how it's used to calculate the P/B Ratio. The script highlights that a low P/B Ratio indicates good value, while a high ratio suggests the stock is expensive. It also discusses scenarios where a P/B Ratio less than one or negative might signal undervaluation or insolvency. The video concludes with a practical example and a tip on where to find pre-calculated P/B Ratios, such as on Yahoo Finance.

Takeaways

• 📈 The Price to Book Ratio (P/B Ratio) is a financial metric used to evaluate a company's market price relative to its book value.
• 💼 P/B Ratio compares a firm's current stock price to its net worth, represented by tangible assets like cash, real estate, and machinery.
• 🚫 It's less useful for companies with significant intangible assets, such as technology firms, where value often lies in software and trademarks.
• 🔢 Calculated as the price per share divided by the book value per share, where book value is found by subtracting liabilities from assets and then divided by the number of shares outstanding.
• 💹 A low P/B multiple (e.g., 2 times) suggests the stock is undervalued, while a high multiple (e.g., 10 times) indicates it might be overvalued.
• 🏢 The ratio reflects investors' willingness to pay a premium for a company's ability to generate more value than its assets are worth.
• ⚠️ A P/B ratio less than one could indicate undervaluation or that the company's assets are outdated or overpriced.
• ❌ A negative P/B ratio is a red flag, suggesting the company's liabilities exceed its assets, posing a high risk for investors.
• 🔎 Price to Book Ratio can be found on financial platforms like Yahoo Finance under the 'Evaluation Measures' section.
• 💭 Investors use P/B Ratio alongside other valuation metrics to make informed investment decisions.

Q & A

What is the price to book ratio?

The price to book ratio, also known as the PB ratio, is a valuation metric that compares a stock's current price to the net worth of the company's assets, also referred to as book value.

What is book value and why is it important in the context of the price to book ratio?

Book value measures how much a company would be worth if it sold off all its assets and paid back all its liabilities. It includes tangible assets like cash, real estate, and machinery. It's important because the PB ratio uses the book value of a company's tangible assets to evaluate companies that build their businesses around these hard assets.

Why might the price to book ratio not be suitable for technology companies?

The price to book ratio might not be suitable for technology companies because the value of a tech company usually lies in its intangible assets, such as software and trademarks, which don't have a physical monetary value attached to them.

How is the price to book ratio calculated?

The price to book ratio is calculated using the formula: price per share divided by the book value per share. The book value per share is found by dividing the company's total book value by the total shares outstanding.

What does a low price to book ratio, such as two times, indicate about a stock?

A low price to book ratio, like two times, is typically regarded as good value, indicating that the stock is currently cheap and may be undervalued by the market.

What could a high price to book ratio, such as 10 times, suggest about a stock?

A high price to book ratio, like 10 times, usually indicates that the stock is more expensive or not good value for the current price per share, suggesting that investors are paying a premium for the stock.

Can you provide an example of calculating the price to book ratio using the fictional Sam's Scooter Company?

For Sam's Scooter Company with a stock price of $50 per share, a total book value of $150 million, and 10 million shares outstanding, the book value per share is $15 ($150 million divided by 10 million shares). The price to book ratio is then calculated as 3.3 times ($50 divided by $15).

What does a price to book ratio of 3.3 times imply about a company's assets and market value?

A price to book ratio of 3.3 times implies that the market is pricing the company's stock at 3.3 times the net value of its assets, suggesting that investors believe the company can use those assets to generate more value than the assets are worth.

What are the potential red flags that the price to book ratio can reveal about a company?

Two potential red flags are a price to book ratio less than one, indicating the stock is trading at less than the book value, which could suggest the company is undervalued or its assets are outdated, and a negative price to book ratio, indicating the company is insolvent with liabilities greater than assets.

Where can investors find the price to book ratio for a company?

Investors can find the price to book ratio for a company on financial information platforms like Yahoo Finance, where it is listed under the 'Evaluation Measures' section in the 'Statistics' tab.