In my recent articles about best and worst performing stocks, I have been reviewing the prospects of those companies and referring to their PBV Ratio.
PBV is an abbreviation for Price to Book Value and is one of the most useful ratios you can use when buying or selling company shares.
It is also very easy to understand and calculate as we will see in this article.
What is a Price To Book Value Ratio?
The Price to Book Value Ratio is also known as the Price to Book Ratio, PB Ratio or PBV Ratio.
It compares the Share Price of one share of a particular company to the Book Value per share of the same company.
What is Book Value Per Share?
Wikipedia has a definition here but it is not the easiest to understand so I’ll give my take on it…
The Book Value Per Share is also known as the Net Asset Value per share and usually abbreviated to NAV.
It is the total asset value of a company less it’s total liabilities, divided by the number of shares the company has.
The NAV method of valuing a business is explained a lot more in the first part of this video:
As explained in the video, net asset values can be found in a company’s Balance Sheet and are always reported in the headlines of the latest company results.
So they are relatively easy to find if you want them.
The reason the NAV is called the book value is because business assets are traditionally written in an asset register and in the days before computer systems, accountants used books to keep records of income, expenses and asset values for example.
How To Calculate a Price to Book Value Ratio?
To calculate a PBV Ratio, you need to divide the share price by the NAV per share.
The number you get from doing this will tell you how much you are overpaying or underpaying for the assets of the business.
Or put another way, whether you are paying less or more for the assets than the assets are valued by the business.
Why am I interested in that, you ask?
Well, if we multiply the share price and the NAV per share figures by the number of shares in the company, we get two other numbers, the Market Capitalization of the company and the total Net Asset Value of the company.
Of course, dividing the market capitalization by the total NAV will also give us the same PBV ratio as we have before (because the number of shares on the top and bottom of the fraction cancel each other out).
Sometimes, this calculation may be easier to do if you have those numbers to hand instead of the share price and NAV per share.
The other reason I mention this, though, is because it is now easier to understand why the PBV ratio is so important and so useful.
The PBV Ratio is a Valuation Tool
If I were considering buying the whole company, then I would want to understand how much the assets of the business are worth.
I would also want to know how my purchase price compared to the value of those assets.
Am I paying 100% of the value of those assets or am I getting the business for less?
This number is the PBV Ratio!
A PBV ratio of 1 means that I am paying a price for the shares which is exactly equal to the net asset value of the shares.
So ideally, we want a PBV ratio below 1 because we all want a bargain right?
Well it’s not quite that simple because some businesses are more asset intensive than others (watch the video if you haven’t already to understand this).
Indeed, it is quite common for PBV ratios to be greater than one and in some industries, for the PBV ratio to be 3, 4, 5 or even higher.
In my recent article about the Facebook IPO, I highlighted how it was being valued in excess of 10 times its net asset value whereas Google was currently being valued at 2.65 times.
It is good practice therefore to compare the PBV Ratios for different companies in the same business sector to get a feel for whether a company’s shares are cheap, expensive or fairly valued compared to the norm or average.
Essentially, that’s what I was doing in my recent 2011 performance articles.
You might want to take a look at some of them, as well as the video, to get a better idea of how useful this PBV Ratio can be.
If you have found this article useful, please leave me a comment below or click on one of the share buttons.
Also, I’m happy to answer any questions you may have so don’t be shy, ask away!