Once again you will be looking for a low value for the price
to book value as it will indicate that a stock is undervalued. This is more
desirable. Growth investors increasingly make use of this metric to identify
the best stocks to invest in.
The book value of equity is defined as the value of
company's assets as shown on the balance sheet. It is the difference between
the book value of assets and the book value of liabilities.
Let us look at an example. If company XYZ has $300 million
in assets and $100 million in liabilities, then the book value for this
particular company would be $200 million. If there are 20 million shares
outstanding, then each share would represent $10 of book value. If the market
price for a share is currently $25, then the P/B ratio would be 2.5 (25/10).
Be wary of companies that are trading for less than their
book value. Also, investors should steer away from stocks with a P/B less than
one. It signifies that the asset value is overstated and the firm is earning a
dismal return on its assets.
The best companies are those that have a high stock price
relative to their book value. They are earning a high return on their assets.
When looking at P/B, pay close attention to the ROE as well. A low ROE in
comparison to the P/B can be problematic.
Book values tend to get distorted. Share buybacks have an
effect on the P/B as the capital gets reduced on the balance sheet. In addition,
the book value plunges when cash is made use of to fund a capital expenditure
for instance.
In the end, the P/B ratio offers a reality check for an
investor and a valuable one at that. The issue with P/B is that it ignores
intangible assets like brand value, intellectual property, goodwill and
patents. Companies like Microsoft are renowned for their significant
intellectual property in comparison to physical property and this ratio does
not capture that aspect.
her
over the long term.
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