One of the most important and closely watched value metric in stock screening is the price-to-book ratio.
Price-To-Book Ratio is a ratio used to compare a stock’s market value to its book value. In other words, It represents the recent closing stock price divided by the theoretical dollar amount per common stock one might expect to receive from a company’s tangible book assets should liquidation take place. Book value is an accounting term denoting the net asset value of a company, calculated by total assets minus intangible assets (patents, goodwill) and liabilities.
It is calculated by dividing the current closing price of the stock by the latest quarter’s book value per share. It is also known as the “price-equity ratio”.
This ratio also gives some idea of whether you’re paying too much for what would be left if the company went bankrupt immediately.
Studies suggesting a low PTB can lead to a strong stock price rise in the future. Value investors would use a low PTB on stock screens, for instance, to identify potential candidates. A lower PTB ratio could mean that the stock is undervalued. However, it could also mean that something is fundamentally wrong with the company.
PTB ratios may also fluctuate with the market. During a down economy, businesses tend to sell for lower prices in both the private and public market, and, accordingly, PTB ratios decline.
Assets may be shown at their historical costs according to the conventions of accounting. The value of an asset is recorded in the books as the price paid for the asset. This is something that does not reveal the actual value of an asset. For instance, if a real estate assets was purchased 30 years ago and these assets are currently recorded at their purchased prices, chances are liquidation value will be significantly higher than the stated book value.
As with most ratios, be aware that this varies by industry. The ratio usually works well only for companies with a good deal of assets on their books. Industry that require more infrastructure capital (for each dollar of profit) will usually trade at PTB ratios much lower than of, for example, consulting firms. This is because intangible assets (goodwill, patents, etc.) are ignored by the book value calculation. Thus, it may not be very applicable to service firms.