Price to Book Ratio or P/B Ratio determines the valuation of the company with respect to its balance sheet strength. The formula used to calculate P/B ratio is:
Price/Book Value = Company’s Market Capitalisation / Total Book Value
Price/Book Value = Latest Stock Price / Book Value Per Share
Both the calculations will give the same result.
Market Capitalisation = Latest Stock Price X Number of shares of the company
Total Book Value = Total Assets less Intangible Assets less Liabilities or
Total Book Value = Total Shareholder’s Funds (excluding Minority Interest) – Debit balance in P&L Account, if any.
Book Value per share = Total Book Value / Number of shares of the company
Thus, Price to Book Value Ratio indicates the multiple that the market is willing to pay for the accumulated equity in the company.
Let us have a look at the FY2018 financials of DLF and Oberoi Realty for understanding P/B value ratio:
Rs. 35,958 crore
Rs. 17,267 crore
Rs. 23,435 crore
Rs. 4,462 crore
Price to Book Ratio
In the above case, a lower Price to Book Ratio may indicate that DLF is undervalued whereas Oberoi Realty trading at a higher Price to Book Ratio may be overvalued.
Price to Book value varies by industry. In general, industries which depend heavily on capital equipment / fixed assets and inventory, such as manufacturing, commodities processing, trading etc. have much of their market value determined by the amount of assets involved in the business. Therefore, the Price/Book Ratio for these industries will be lower. For this reason, all financial lending businesses (where capital is the main product) such as banks, housing finance institutions, gold loan companies, micro finance institutions are valued based on the P/B value multiple.
On the other hand, for service industries that depend less on assets to generate revenue and more on labour work, for example service industries where employee skills may be the primary revenue earner, the Price/Book Ratio will be high.
One way to differentiate is that for industries having less usage of assets, the market price of the stock depends more on other attributes of the business and less on the physical assets and thus the ratio can differ drastically.