Explainer: What Is Price-To-Book Value?

The Indian stock market is touching new highs. The BSE Sensex touched the 62,000 mark and closed at an all-time high of 61,981 on November 16, 2022. Given the scenario, experts feel that valuations are not cheap, and investors should do a bit of cherry-picking and invest in undervalued stocks for better margin of safety.

But ascertaining the valuation of stocks is not a simple exercise. You will need to use certain valuation techniques to analyse whether a particular stock is over or undervalued. One of the commonly used ratios that aids in this analysis is price-to-book value (PBV). It is a valuation tool that is used to identify value stocks. Let’s understand what it is, and the advantages and limitations of using it to identify such stocks.

What Is It?

• To understand PBV, we will first need to understand what book value means. This is also called net worth and denotes the value of equity or a share on the company’s balance sheet (not on the stock market).
• The PBV ratio, as the name suggests, is calculated by dividing the stock market price of the stock by the company’s book value per share.
• For example, Coal India Limited’s book value is Rs 70 per share and the market price of its share is Rs 232 apiece, as on November 17, 2022. This means that Coal India’s PBV is 3.31 (232/70).

What Does It Denote?

• It reflects the amount the market is paying for each rupee of the company’s book value per share.
• In Coal India’s example, a PBV ratio of 3.31 means that the market is paying Rs 3.31 for each rupee of the company’s book value per share.
• PBV ratio of a stock below 1 means that the market price of the stock is less than its book value. As the market price is above the book value, such PBV indicates an undervalued stock.
• A low or high book value does not necessarily indicate whether a stock is under or overvalued. For less capital-intensive companies (such as IT firms), the value depends on intangible assets, which PBV does not capture.

When Should You Use It?

• There are two ways to look at valuations of companies—earnings per share (EPS) and book value per share.
• PBV ratio is more useful if the company’s earnings are either negative or volatile. As the book value is relatively more stable than earnings, PBV is a preferred ratio for evaluation for companies with volatile earnings.
• Book value is influenced by accounting norms. So, comparison, on the basis of book value, between companies with different accounting norms could be misleading.