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How to Use the Book Value and the P/B Ratio to Find Undervalued Stocks (With Formulas and Examples)




The Book Value and Price-to-Book Ratio (P/B Ratio) Explained: From Definition to Formulas & Examples

If you are a value investor, you might have heard of the price-to-book ratio (P/B ratio), a financial metric that compares a company’s market value to its book value. But what exactly is the book value and the P/B ratio, and how can they help you find undervalued stocks? In this blog post, we will explain the meaning, formula, and interpretation of the book value and the P/B ratio, and provide some examples of how to use them in your investing decisions.

What is the book value?

The book value of a company is the value of its assets minus its liabilities, as reported on its balance sheet. It represents the net worth of the company, or the amount of money that would be left over if the company sold all its assets and paid off all its debts. The book value can also be divided by the number of outstanding shares to get the book value per share (BVPS), which is the value of each share of the company.

The book value is often used as a measure of the intrinsic value of a company, or the value that is based on its fundamentals and not on its market price. However, the book value has some limitations, such as:

  • It does not reflect the market value of intangible assets, such as patents, trademarks, or goodwill, which can be significant sources of value for some companies.
  • It does not account for hidden assets or liabilities, such as off-balance-sheet items, contingent liabilities, or deferred taxes, which can affect the true financial position of a company.
  • It does not consider the future earnings potential or growth prospects of a company, which can influence its market value.

Therefore, the book value should not be used as the sole indicator of a company’s value, but rather as one of the factors to consider in your analysis.

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

The price-to-book ratio (P/B ratio) is a financial metric that compares a company’s market value to its book value. It is calculated by dividing the company’s current stock price per share by its book value per share (BVPS). The formula for the P/B ratio is:


The P/B ratio reflects the value that market participants attach to a company’s equity relative to its book value. A high P/B ratio means that the market is willing to pay more for a company’s shares than its book value, which implies that the market expects the company to generate higher returns or growth in the future. A low P/B ratio means that the market is paying less for a company’s shares than its book value, which implies that the market is undervaluing the company or that the company is facing challenges or risks.

Many investors use the P/B ratio to find undervalued stocks. By purchasing an undervalued stock, they hope to be rewarded when the market realizes the stock is undervalued and returns its price to where it should be, according to the investor’s analysis. A common rule of thumb is that a P/B ratio of less than 1.0 indicates that a stock is undervalued, while a ratio of greater than 1.0 indicates that a stock is overvalued. However, this rule is not absolute, as different industries and sectors may have different average P/B ratios, and the P/B ratio should be compared with other valuation metrics, such as the price-to-earnings ratio (P/E ratio), the price-to-sales ratio (P/S ratio), or the price-to-cash-flow ratio (P/CF ratio).

Examples of the book value and the P/B ratio

To illustrate how the book value and the P/B ratio work, let’s look at some examples of companies from different industries and sectors. We will use the data from the most recent financial reports as of December 2023, and the stock prices as of December 28, 2023.

Example 1: Apple Inc. (AAPL)

Apple Inc. is a technology company that designs, manufactures, and sells consumer electronics, software, and online services. It is one of the most valuable companies in the world, with a market capitalization of $2.8 trillion as of December 28, 2023.

According to its balance sheet as of September 25, 2021, Apple had total assets of $341.1 billion and total liabilities of $258.6 billion, resulting in a book value of $82.5 billion. It also had 16.6 billion shares outstanding, resulting in a book value per share of $4.97. Its stock price as of December 28, 2023 was $168.64, resulting in a P/B ratio of 33.9.

This means that the market is paying 33.9 times more for Apple’s shares than its book value, which indicates that the market has high expectations for Apple’s future performance and growth. Apple’s P/B ratio is also much higher than the average P/B ratio of the technology sector, which is around 7.0, according to Morningstar. This suggests that Apple is overvalued compared to its peers, or that it has a competitive advantage or a strong brand that justifies its premium valuation.

Example 2: Walmart Inc. (WMT)

Walmart Inc. is a retail company that operates a chain of hypermarkets, discount stores, and grocery stores. It is one of the largest companies in the world by revenue, with a market capitalization of $395.8 billion as of December 28, 2023.

According to its balance sheet as of October 31, 2021, Walmart had total assets of $252.5 billion and total liabilities of $163.9 billion, resulting in a book value of $88.6 billion. It also had 2.8 billion shares outstanding, resulting in a book value per share of $31.64. Its stock price as of December 28, 2023 was $141.36, resulting in a P/B ratio of 4.5.

This means that the market is paying 4.5 times more for Walmart’s shares than its book value, which indicates that the market has moderate expectations for Walmart’s future performance and growth. Walmart’s P/B ratio is also close to the average P/B ratio of the consumer defensive sector, which is around 4.0, according to Morningstar. This suggests that Walmart is fairly valued compared to its peers, or that it has a stable and consistent business model that reflects its valuation.

Example 3: Bank of America Corporation (BAC)

Bank of America Corporation is a financial company that provides banking, investment, and other financial services. It is one of the largest banks in the world by assets, with a market capitalization of $367.4 billion as of December 28, 2023.

According to its balance sheet as of September 30, 2021, Bank of America had total assets of $3.1 trillion and total liabilities of $2.8 trillion, resulting in a book value of $300.9 billion. It also had 8.6 billion shares outstanding, resulting in a book value per share of $34.88. Its stock price as of December 28, 2023 was $42.64, resulting in a P/B ratio of 1.2.

This means that the market is paying 1.2 times more for Bank of America’s shares than its book value, which indicates that the market has low expectations for Bank of America’s future performance and growth. Bank of America’s P/B ratio is also lower than the average P/B ratio of the financial services sector, which is around 1.5, according to Morningstar. This suggests that Bank of America is undervalued compared to its peers, or that it has some challenges or risks that depress its valuation.

Conclusion

The book value and the price-to-book ratio (P/B ratio) are useful tools for value investors to evaluate a company’s valuation relative to its assets and liabilities. However, they are not the only factors to consider, as they have some limitations and may not reflect the true value of a company. Therefore, investors should also look at other financial metrics, such as earnings, cash flows, growth rates, and dividends, as well as qualitative factors, such as competitive advantage, industry trends, and management quality, to make informed and rational investing decisions.

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