The price-to-book ratio (P/B ratio) is an indicator used to rate a publicly-traded company. The P/B ratio is calculated by dividing the price of a stock by its book value.
In order to perform this calculation, the book value of the stock is required. To find this, you need to divide the book value of the issuing company (which in the simplest form is based on its actual capital including real estate, plant and machines) by the number of shares that make up the company.
For example, if a company has a book value of 6 billion Swiss francs and 300 million shares in circulation, the book value of each of its shares is 20 francs. If you were to divide this share value by the going share price of 25 Swiss francs, you would get a 0.8 P/B ratio.
However, there is no general rule of thumb which dictates how P/B ratios should be interpreted. Because P/B ratios are based on hard assets, it’s important to make a differentiation between companies in different industries.
Companies in the plant-manufacturing and motor car industries will generally have more physical assets than software companies or similar firms. This affects their P/B ratios.
Because of this, P/B ratios are only really helpful when used to compare stocks issued by multiple companies in the same industry.
A P/B ratio of less than 1,0 means that a company’s stock is worth less than its combined real-estate, warehouses and other tangible assets. These under-valued stocks can sometimes offer exceptional investment value.
It’s important to note, though, that book values are relatively easy to manipulate. The book value of real estate is often listed at the price which the company paid for it. The current value of the property may be a great deal lower than the listed price. Many companies put off updating their book values for as long as possible in order to remain attractive.