Do you know Investor’s and the market analyst’s use various methods to evaluate a company’s financial health and profitability. And on those method’s, they most commonly use so many Ratios to evaluate the financials Just like PE Ratio that we have discussed early article and like that one of them is PB Ratio.

If you have not read that article yet go check it now. Anyway, apart from PE Ratio PB Ratio is also a very important factor or ratio that is widely used to assess the value of company stock. So, Let’s discuss about PB Ratio in Detail.

PB Ratio Definition:

PB Ratio is a metric used by analyst to evaluate company’s value in relative to Book Value of that company. It measure’s the company’s Value in relation to company’s asset that were mentioned in company’s financial statements. So in general you can say that to evaluate any company’s PB Ratio you have to first get any company’s asset and liability statement.

ref- investopedia

How To Calculate PB Ratio? Explained With Example:

Hence, we know that PB Ratio is the metric that is used to evaluate any company’s value relative to its Book Value. Whereas Book Value is calculated by taking “total value of company’s asset minus its liabilities”.

So, let’s understand this by an example. Let’s assume there is a company named ABC ltd of which 1 Crores shares are trading in market at the price of INR 200 each. And company has assets of worth 2000 Crores INR and Have liabilities of INR 1000 Crores.

So according to above data let’s calculate the PB Ratio of ABC Ltd.

Book Value of Company Per share

PB Ratio = 0.5

IN this case you can see company ABC Ltd. PB Ratio is 0.5 which is less than 1 and it indicates that any Investor is only willing to pay only INR 0.5 for every One book of value. And it is an indication that company is undervalued at this time

High Or Low PB Ratio Which One Is Better:

Do you know any company’s PB Ratio depends upon the so many factors, such as industry it operates in, its growth prospect its profitability and also, it’s financials stability.

Generally, a lower PB Ratio indicates that market is valuing the company at discounted price. Which can be an indication of undervaluation.  While a higher PB Ratio indicates that market is valuing company at premium price. Which may be an indication of overvaluation.

NOTE: – It’s not Necessary or important that low PB Ratio always meant that stock in undervalued and high PB Ratio doesn’t always mean that company is overvalued.

For Example

If a company is operating in declining industry, it might have a lower PB Ratio and it doesn’t mean that it is good investment opportunity. Because industry is declining.

While as, there may be a company which is operating in evergreen industry and its growth prospect is high and its PB Ratio is also high in that case it’s doesn’t mean that company is overvalued rather than that it may be a good investment opportunity because of the future growth prospects and evergreen rising industry.

Now let’s assume that there is Two company’s A and B operating in the same industry

While as Company A’s share price is INR 100 and company B’s Share price is INR 300 respectively and so on Book value of company A and B is 100 for both.

So according to this data

In this case company A has lower PB Ratio of 1 And company B has higher PB Ratio of 3. Which indicates that company A is Undervalued and company B is Overvalued. Because both the companies are operating in the same industry.

Hence company A with PB Ratio 1, is looking as Good Investment opportunity but here comes some other factors like its financial statements and its future growth prospects. If Company doesn’t have good financial statements and doesn’t have strong future growth prospects It will not be a good investment choice, according to other factors.

While as company B which has higher PB Ratio Of 3, if its other factors like financial statement and future growth prospects are very good. It may be a good investment choice, according to these factors.

So now you can understand that PB Ratio Can not alone be A factor for making an investment decision. Or tool for fair valuation of any company. One must have to use other metrics in conjunction to evaluate the company’s value.

What Does It Reflects If PB Ratio is High Or Low:

As you know we discussed that PB Ratio is alone not a factor of valuation of a company. But in general, it gives us some Indications like High PB Ratio reflects that company may be overvalued at this time.

And low PB Ratio reflects that company may be undervalued at this time. And here we must look for other metrics for better investment decision. Such as PE Ratio, EV/EBITDA etc.

Negative PB Ratio:

Ideally it is Not Possible that any company has negative PB Ratio. However, in some cases book value per share at any company has less assets compared to its liabilities.

Since PB Ratio cannot be negative it may very close to zero which may reflect that the company’s share is undervalued and some investors may find it as good investment opportunity by considering other factors.

What is Ideal PB Ratio:

There is no ideal number that can fit to this. Because it can very upon industry type, its sector and its other financial metrics as well.

Hence in general PB Ratio between 1 and 3 is considered to be reasonable. But this can very depend upon Industry and its sector.

Importance Of PB Ratio:

Now let’s discuss about the importance of the PB Ratio. We can understand this by considering following points.

Measures Value:

It measures value of stocks based upon the company’s assets. And forces investors to think about company’s assets.

Provides basis of comparison:

Hence, we know that PB Ratio is best for comparing companies which are operating in same the industry and sector. Specially in companies which are operating in asset reliable industry like manufacturing and real estate.

Help in decision making:

While PB Ratio is not the only best metric to take decision on investing, but with conjunction of other metrics like PE Ratio, PEG Ratio it can be a decision maker.

Considers tangible asset:

Hence, we know that PB Ratio depends upon the tangible assets of the company that’s why it became very important metric to consider. While other metrics mostly depends upon the company’s current cash flow and earnings.

What are the Limitations of PB Ratio?

Now you understand that PB Ratio can be calculated using its Book Value per share and Market price per share. Hence, there are some limitations also. Let’s discuss about this in 4 points.

Not good for companies with low value of tangible assets:

PB Ratio is not good for companies which have very low value of tangible assets in compared to their high value intangible assets. Like Meta, Google, and Microsoft. These companies have very high value of intangible assets as compared to their tangible assets which are very low.

Only for companies in same sector:

It can be suitable for comparing companies operating in same sector. If you use it to compare companies operating in different sectors, it will not be relevant and defining factor for investment decision.

It does not consider future growth potential:

As we know that it considers only assets to determine the value of a company but in some cases, it is also required to see future growth potentials. And here PB Ratio takes a break.

Can be misleading for high debt level companies:

PB Ratio may be misleading for the companies with high debt level. Because if any company’s accounting method allows for the capitalization of their debt. Their book value may be artificially inflated. And in this condition PB Ratio is not useful.

When to use PB Ratio?

Let’s discuss when to take action’s using PB Ratio. Below points may be helpful for explaining this.

1. It is very good for companies operating in same sector and industry because these companies may have similar asset classes.
2. PB Ratio is best for companies with high value of tangible assets. When you are going to compare companies which are operating in real estate development or in manufacturing field their assets may play defining role.

What are the alternatives of PB Ratio?

PB Ratio is good metric to evaluate any company’s value but there are some alternatives. Which are also very useful and handy to that same.

1. PE Ratio: It compares company’s current stock price to its earning per share.
2. PEG Ratio: By this method any company’s valuation determined by comparing company’s growth rate to its PE Ratio.
3. Dividend Yield: by this metric any company’s valuation determined by its dividend income potential.
4. EV/EBITDA: This metric is used to determine any company’s valuation based on its operating income.
5. Price to sales Ratio (P/S): As the title suggest the valuation of any company is determined by using its revenue and market capitalization.
6. Discounted cash flow Analysis: It estimates any company’s intrinsic value based on future estimated cashflow of a company.

PE Ratio Vs PB Ratio Which One Is Better?

Both the metrics are very useful and handy to use. And the choice depends upon the investment strategy used by investor. And also, choice between these metrics depends upon the nature and type of the sector.

Let’s make small comparison between two

So its recommended to use all the related metrics in conjunction to evaluate and compares company’s before making any investment decision.

Top 5 companies with High PB Ratio

Let’s see some of the top 5 Indian company’s which have considered to have High PB Ratio.

 source tickertape.in

Top 5 companies with Low PB Ratio

Let’s see some of the top 5 Indian company’s which have considered to have low PB Ratio.

 source tickertape.in

Conclusion:

In this article we discussed about PB Ratio. We also discussed about its use cases and various aspects related to this ratio. Wi did comparison between PB Ratio and PB Ratio also.

We hope this article may helped you to understand about the PB Ratio metric if you found this article helpful, please share it.

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