Sep 13, 2004|
P/BV: Understanding the concept
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
|Reserves & surplus
||Other current assets
||Deferred tax assets
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.
* - CY07, # - FY08 Estimate
||Net worth (Rs m)
||No. of shares (m)
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.
More Views on News
May 5, 2016
Not if the Establishment has anything to do with...
May 5, 2016
The data from the Income Tax department does not match with the data put out by the Reserve Bank of India.
May 4, 2016
The secret to Warren Buffett's success all these many years: buying companies that generate wads of cash with very low capital requirements.
May 4, 2016
The financial world remains crooked not just in the US bit in India too.
May 4, 2016
Data shows that tremendous amount of black money is generated even when homes are rented out.
More Views on News
Apr 22, 2016
A message from Ajit on Equitymaster's 20th Anniversary...
May 3, 2016
Around 13.9 lakh Indians pay nearly four-fifth of the individual income tax.
Apr 25, 2016
Practice GARP Investing For Good Long Term Returns.
Apr 28, 2016
Mr Narendra Modi has laid down an ambitious plan to create 100 GW of solar capacity by 2022. However, are the projects financially viable at the bids at which they are being carried out? Read on to find out.
Apr 22, 2016
Asad Dossani discusses the importance of trust at Equitymaster and the Daily Profit Hunter
© 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. Use of the information herein is 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 a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Before acting on any recommendation, investors 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: 91-22-6143 4055. Fax: 91-22-2202 8550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407