| |
Jul 9, 2012
The basics of price to book value (P/BV)
The price to book value (P/BV) ratio is a widely used valuation parameter used for valuing stocks. But what does P/BV mean and how can investors use this parameter to value their investments? In this article, we will try and simplify this concept.
How is price to book value calculated?
P/BV is arrived at by dividing the market price of a share with the respective company's book value per share. Book value (BV) is equal to the shareholder's equity (share capital plus reserves and surplus). BV can also be derived by subtracting current and non-current liabilities from total assets. For the banking and finance companies, book value is calculated as 'share capital plus reserves minus miscellaneous assets not written off. This formula then takes care of the bank's NPAs (non performing assets) and gives a correct picture.
Let us take up an example and calculate the latest book value Infosys.
FY12 Balance sheet of Infosys
| Liabilities |
Rs bn |
Assets |
Rs bn |
| Equity capital |
3 |
Cash |
206 |
| Reserves & surplus |
310 |
Other current assets |
97 |
| Current liabilities |
69 |
Fixed assets |
61 |
| Non-current liabilities |
4 |
Non-current assets |
17 |
| |
|
Deferred tax assets |
5 |
| |
386 |
|
386 |
If one were to take a look at Infosys' consolidated balance sheet for FY12, as mentioned above, book value will be arrived at by adding Rs 3 bn (equity capital) and Rs 310 bn (reserves and surplus), which equals to Rs 313 bn. Conversely, when we deduct current and non-current liabilities from total assets, we shall arrive at a similar figure. Now, by dividing this book value (Rs 313 bn) by the issued equity shares of the company (approx 574 m), we would arrive at the book value per share figure, which is Rs 545. This will be our denominator for calculating the P/BV for the Infosys stock, which currently stands at about 4.5x (at market price of Rs 2,438).
What does P/BV indicates?
Usually, P/BV figures for companies in the services industries like software and FMCG are high as compared to those of companies in the sectors like auto, engineering, steel and banking. This is due to sectors such as software and FMCG have low amount of tangible assets (fixed assets etc.) on their books and therefore, the P/BV may not be a correct indicator of valuation. On the other hand, capital intensive businesses such as auto and engineering require large balance sheets, i.e., they have a large amount of fixed assets and investments. P/BV is a good indicator of measuring value of stocks from such capital intensive sectors.
If a company is trading at a P/BV of less than 1, this indicates either or both of the two -
- Investors believe that the company's assets are overvalued, or
- The company is earning a poor return on its assets.
A high P/BV indicates vice versa, i.e., markets believe the company's assets to be undervalued or that the company is earning and is expected to earn in the future a high return on its assets. Book value also has a relationship with the Return on Equity of a company. In fact, book value can also be termed as equity (equity capital plus reserves and surplus). As such, for a company that earns a high return on equity, investors would be ready to give the stock a high P/BV multiple.
What does P/BV fail to indicate?
P/BV indicates the inherent value of a company and is a measure of the price that investors are ready to pay for a 'nil' growth of the company. As such, since companies in the services sectors like software and FMCG have a high growth component attached to them, Price to Earnings ratio (P/E Ratio) would be a better method of gauging valuations.
Investors would do well to note that P/BV should not be used for valuing companies with high amount of debt. This is because high debt marginalizes the value of a company's assets and, as such, P/BV can be misleading.
We hope this article was able to throw some light on the concept of P/BV and its relevance from an investor's viewpoint. The ratio has its shortcomings that investors need to recognise. However, it offers an easy-to-use tool for identifying clearly under or overvalued companies.
This article was originally written on September 13, 2004 and has been updated.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 16, 2017
All across the country, the old gods become devils. New, gluten-free gods take their places...
Aug 16, 2017
And what it has in common with beating the stock market too.
Aug 16, 2017
Ensure your financial Independence, and pledge to start the journey towards financial freedom today!
Aug 14, 2017
Last week's correction is making a number of Super Investor stocks look a lot more attractive...
More Views on News
Most Popular
Aug 7, 2017
The data tells us quite a different story from the one the government is trying to project.
Aug 4, 2017
The small-cap space is full of small players that are clear proxies to great growth stories and Indian megatrends.
Aug 8, 2017
Bharat-22 is one of the most diverse ETFs offered so far by the Government. Know here if you should invest...
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 7, 2017
Raksha Bandhan signifies the brother-sister bond. Here are 7 thoughtful financial gifts for sisters...
More
Copyright © Equitymaster Agora Research Private Limited. All rights reserved. Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results. SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407 | |
|
|
Sunil Yadav
May 23, 2016The information was very useful. Is it possible for you to send valuation of any banking company by p/bv method ?