What is P/B ratio? When to use and when not to use?

 What is the P/B ratio? When to use and when not to use?

Investors are using many methods before investing in any stock in order to evaluate the objective of the investment The P/B ratio is one of them But is very dangerous ratio as if you don’t know about this stock where to use and where not to use?  If you use it wisely then it will be more beneficial and if you made slightly any mistake then it will create a mess up.

Sometimes it is difficult to analyze the earnings of the company like some times the growth of the company is negative for the current a year and in the future, It is expected for handsome returns it is not making losses every time in such cases P/E ratio will not give the proper direction in such cases P/B ratio is useful to analyze the stock price.

So let us know about the P/B ratio.

Price to Book ratio (P/B ratio) = Current share price/Book value per share.

The relation between share prices is how many times the share price with respect to book value.

Here Book Value = Net tangible Asset – Liability

You called it a net worth of the company or shareholder’s equity as per account.

Asset means Net the tangible asset of the company as per account like a property like land, machinery, vehicles, and infrastructures, etc.

Tangible asset do not include brand, technology,

Liabilities means paying of money to others like interest to bank in case of a loan or any debt,

In simple language if you sell a company’s all asset and pay the liabilities then what is remaining is a book value.

Tangible Asset= 100	60.	Net worth or Shareholder equity
	40	Liability

Here Book value = 100 – 40 = 60

Means if the company gets bankrupted then shareholders will get only 60. But this is the total book value.

Suppose No of shares = 20

B. V. per share = Book value / No of shares.

                                                   = 60/20. = 3.

So, Her P/B ratio = Current Share price / Book value per share

Let us assume the current share price of this company as on today is 30 then

P/B = 30/3 = 10

Another formula to calculate P /B ratio is = Total Market Value/ Total Book Value

Here total market Value is total market capitalization on NIFTY or SENSEX

Market capitalization is = number of shares X share price.

If we calculate here we will get = 20*30/ 60 = 10.

What this value indicates:

·         For 1 Rs of the net asset, you are paying 10 Rs more premium to that share.

Why Market is ready to pay a premium on Book Value?

1.       Perception of future growth of the company

2.       Value of intangible asset like Brand, Technology Copyrights, Employee, Leadership, Strategy etc.

When to use P/B ratio?

·         You cannot apply this ratio to each Industry.

·         You can use the P/B ratio: For Asset of heavy Industries e.g   Manufacturing, Oil & Gas, Chemical Industry, Infrastructure, Real Estate, etc.

In the above case, the P/E ratio may not be useful but the P/B ratio will be useful and in this case, P/B will be lower.(Book value comes in the denominator  of the formula)

·         While evaluation of the P/B ratio it is also to be consider the quality of the asset whether it is appreciating or depreciation asset.

1.       Appreciating assets like land, Gold, Investment etc.

2.       Depreciating Asset are Machinery

If P/B is less than 1 what does it indicates?

·         There may be bad news from the company or A lower P/B proportion can imply that the stock is underestimated or something is in a general sense amiss with the organization. This proportion gives you a thought in case you're paying a lot for what might be left if the organization defaulted on some loans

When not to use the P/B ratio?

·         For technology & Service Industries: Software, Services, and Consulting, etc. as in this case the tangible assets are very minimal, intangible assets are more like technology, brand, employee so it's P/B remains always high because the book value is very low. So in this case the P/E ratio is useful. ( For P/E ratio please visit my earlier blog)  

Let us examine by taking current market data.

Please see the snapshot of Reliance Industries ( Taken from IIFL website) Here you will get the current market price and book value also. It will be:

2086/685 = 3.04.

Let us examine by comparing peer (same type of) industries like IOC.BPCL etc.

Sr No	Industry	Current Share Price	Book Value	P/B ratio
1	Reliance Industries	2086	670	3.11
2	BPCL	409	154	2.65
3	IOC	85	100	0.85
4	HPCL	200	190	1.05
5	MRPL	32	45	0.71

 In the above example, P/B for Reliance Industries is higher than the others, because in reliance Industries other types of assets included JIO, Petrochemical, Refinery, Life Sciences, etc. So it will remain always on the higher side. This value indicates that the market is paying a premium of 3.11 times more.

So Always compare P/B ratio of peer Industries before investing in the stock.