Anyone who would wish to acquire a company has to buy all its shares at the present market price. (The market price of each share x total number of shares is what we call market capitalization.)

Price to book ratio is calculated as follows –

Market capitalization / Book value OR

The market price of share / Book value of a share.

Both the Market price and book value of the shares of any listed company are readily available on websites of finance. So it is therefore not necessary to work out the value. Let us try to understand the ratio and also its significance.

P/B gives us an idea as to what the market is willing to pay for the book value of the company. A higher P/B means that the market is willing to pay more for the book assets of the company. Some investors believe that a high P/B indicates an overpriced stock.

One has to be cautious while using P/B ratios. A price to book ratio that is low could mean:-

1. That the stock is being traded at a discounted price which and is a perfect opportunity to buy.

2. It could mean that there is something wrong fundamentally with the company.

3. It could be that the book value of assets of the company is overstated in their balance sheet.

MORE ON P/B

· Any kind of distortion in the book value of the assets of a company will affect the P/B ratio. A company for instance would have bought land 15 years back. The balance sheet value would be the price paid during acquisition, 15 years ago. It is only natural that the asset price would have gone up in value by several Crores, but this will not be seen in the balance sheet. The P/B ratio of a company may appear to be expensive, but it may be a stock that is undervalued.

· Software or IT companies, relying on intellectual property may show very high P/B ratios. As these companies are not capital intensive, investment in solid assets will be very less. Being intellectual assets, P/B is not suitable for valuing these kinds of stocks.

· Assets of infrastructure, financial institutions, banks, and manufacturing companies are best suited to be valued with this ratio.

· Companies with a high ROE will have a high P/B and vice versa as ROE and P/B are connected.