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P/BV: Understanding the concept - Views on News from Equitymaster

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P/BV: Understanding the concept

Sep 13, 2004

Apart from the price-to-earnings (P/E) ratio, another parameter that is commonly used to value stocks is price-to-book value (P/BV). But what does P/BV means and how can investors use this parameter to value their investments? In this article, we will try and simplify this concept.How is P/BV calculated?

P/BV is a valuation ratio and is arrived at by dividing the market price of a share with the respective company's book value per share. Now, book value is equal to the shareholder's equity (share capital plus reserves and surplus). Book value can also be arrived at by subtracting current liabilities and debt 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 and gives a correct picture.

FY08 Balance sheet of Infosys
LiabilitiesRs mAssetsRs m
Equity capital2,860Cash69,500
Reserves & surplus135,090Other current assets60,680
Current liabilities41,910Fixed assets47,770
    Investments720
   Deferred tax assets1,190
  179,860  179,860

If one were to take a look at Infosys' consolidated balance sheet for FY08, as mentioned above, book value will be arrived at by adding Rs 2,860 m (equity capital) and Rs 135,090 m (reserves and surplus), which equals to Rs 137,950 m. Conversely, when we deduct current liabilities from total assets, we shall arrive at a similar figure. Now, by dividing this book value (Rs 137,950 m) by the issued equity shares of the company (approx 572 m), we would arrive at the book value per share figure, which is Rs 241.2. This will be our denominator for calculating the P/BV for the Infosys stock, which currently stands at 6.6x.

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 because companies from the sectors like software and FMCG have low amount of tangible assets (fixed assets etc.) on their books and, as such, the P/BV may not be a correct indicator of valuation. On the other hand, old economy sectors like auto and engineering have large balance sheets, i.e., they have a large amount of fixed assets and investments. As such, P/BV is a good indicator of measuring value of stocks from these sectors.

What does P/BV indicates?

P/BV is a good metric to value stocks of companies in the capital-intensive industries like engineering, automobiles and banks, which have large amount of tangible assets in their books (balance sheet). If a company is trading at a P/BV of less than 1, this indicates any 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, P/E and not P/BV is a right measure of their valuations.

    Net worth (Rs m)No. of shares (m)BVPS (Rs)CMP (Rs)P/BVBV/P
    Infosys137,950 572 241 1,583 6.6 15%
    HUL*15,082 2,178 7 220 31.8 3%
    Tata Motors86,975 386 226 412 1.8 55%
    SBI612,364 635 965 1,227 1.3 79%
    BHEL#110,189 490 225 1,460 6.5 15%
    * - CY07, # - FY08 Estimate

  • P/BV should not be used for valuing companies with high amount of debts. 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 over valued companies.


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21 Responses to "P/BV: Understanding the concept"

SIDDHANT RAGHORTE

Apr 2, 2017

P/E &P/B V ratio are the key indicators for analysis of Stock position. For the debt part whether secured loans and unsecured shown in B/S are really true and trustworthy or shall it defeat the true purpose while deriving the book value. In real sense,things are manipulated and window-dressed properly for borrowing funds from banks. Ultimately,resulted in high NPAs,whom to condemn for this jugglery.

Like (1)

Srinivasn

Feb 4, 2017

The article is simple and educating. But it does not explain how to use it for picking stocks for investment keeping in view other parameters. A high P/BV for companies is not always safe. Trump Bump and consequent fall of share prices and values of IT stocks is a case in point.
Equity master should educate investors how to pick good stocks keeping in view various parameters, with live examples.

Like (3)

Kirtikumar Wani

Oct 25, 2016

Very interesting and educating.

Like (3)

Sumit Agrawal

Apr 16, 2014

thanks for this post.
it provide complete information and easy to understand.
but why P/BV should not used for companies have low fixed assets??
please elaborate the point.

Like (1)

P.SATYANARAYANA

May 17, 2013

It is excellent explain to new market traders. It has given very useful information to select a cheap stock, which will be given good growth in future.

Like (1)

vasudevan

Apr 26, 2013

Very educative indeed...
It is like teaching alphabet( Here the basics of share) to a small tiny tot....
Kudos keep it up

Like (3)

vasudevan

Apr 26, 2013

Very educative indeed...
It is like teaching alphabet( Here the basics of share) to a small tiny tot....
Kudos keep it up

Like (1)

venkatraman

Aug 21, 2012

good that the interpretations of P/Eand P/BV values have been explained very well and where to use them

Like (1)

doshi

Aug 13, 2012

Very simple and easy to understand. Thanks

Like (1)

Shanil

Nov 12, 2011

Very good explanation and easy to understand. Eventhough P/BV is not the only criteria one should look for before picking a stock but a better understanding of this concept will help a person who is into value investing. I would say that the most important parameters for analyzing a stock are P/BV, P/E, Net sales, ROIC and debt to net ratio.

Like (1)
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