# PB Ratio

Let’s first understand book value of a stock. Book value broadly represents the amount that a shareholder can recover from a company if the company decides to shut its business today. From our articles about balance sheet items we are aware of the terms assets and liabilities. Suppose a company XYZ Inc.is shutting down its business, it will have to sell all assets and recover money and at the same time it will have to repay all its loans and liabilities. Let’s assume XYZ Inc. received INR 500 crore through asset sale and has a liability of INR 300 crore in the form of bank loans. After paying back the loans, the company will have INR 200 crore left which can be distributed to owners/shareholders. In this case book value of XYZ Inc is INR 200 crore. If the company has 20 crore shares outstanding, each shareholder will then receive INR 10 (200/20) which is the book value per share. Now suppose XYZ is a publicly listed company and the current stock price is INR 15. Price to book value ratio is defined as the current price divided by book value per share. In XYZ Inc.’s case price to book value ratio would be 1.5. This means that you need to pay more to buy a stock, than what will accrue to you if the company decides to shut down its business today.  Investors will buy at this price only if they believe that in future, value of net assets will grow as company progresses. If the value is below 1, then it usually means that investors do not believe that the company will be able to recover the book value.

Price to book value ratio of less than 1 could indicate that the stock is undervalued and it is a good investment opportunity. The ratio could also be less than 1 because investors believe that the company will not do very well in the future and might not be able to recover the amount represented by the book value. Hence it is prudent not to base investment decision on just PB ratio. And just like in the case of PE ratio, PB ratio of 2 different companies can be compared only if they operate in the same sector. A company’s current PB ratio can also be compared with its historical ratio.