Price to Book Ratio: What It Measures, a Worked Example and When It Works

The price to book formula

Price to book = share price ÷ book value per share
= market capitalisation ÷ shareholders' equity
Book value per share = (shareholders' equity − preferred stock) ÷ shares outstanding

Shareholders' equity is the balance-sheet total of share capital, retained earnings and reserves: what would be left for common shareholders if the assets were sold at their carrying values and the liabilities paid. PackCo, the fictional packaging maker from the what is ROIC article, has $1,150 million of equity and 100 million shares, a book value of $11.50 a share. At a $27 share price its market capitalisation is $2,700 million and its price to book ratio is 2,700 ÷ 1,150 = 2.3×. The market values the company at more than twice its accounting net assets, which is normal for a profitable business and says nothing on its own about whether the shares are cheap.

Two refinements are common. Tangible book value removes goodwill and acquired intangibles, leaving the assets that could be sold or lent against; for an acquisitive company it can be a fraction of reported equity. And for a company that has issued preferred shares, subtract the preferred stock first, since it ranks ahead of the common equity the ratio is meant to measure.

What book multiple a business deserves

Book value earns a premium when the company earns more on it than investors require. For a business growing its equity at a steady rate g, paying out the rest, with return on equity ROE and a required return r, the justified price to book is:

Justified P/B = (ROE − g) ÷ (r − g)

PackCo earns a 17.6% return on equity. With 3% long-run growth and a 9% required return, its justified multiple is (0.176 − 0.03) ÷ (0.09 − 0.03) = 2.4×, which is close to the 2.3× the market pays. The table shows how quickly the multiple moves with the return:

A company earning exactly its cost of equity deserves book value and no more; one earning less deserves less than book, which is why a P/B below 1 is often correct rather than a bargain. The return on equity formula article explains the numerator, and the same logic gives the good P/E ratio its shape.

When price to book works

The ratio is most useful when book value is a fair statement of the capital in the business, which is true when the assets are financial or are carried close to what they would fetch:

• Banks. Loans and securities are the business, they are valued at or near market, and the equity cushion is what regulators and depositors rely on. Bank investors speak in price to tangible book and return on tangible equity.
• Insurers. Investment portfolios and reserves dominate the balance sheet; book value, adjusted for unrealised gains, is the base that underwriting returns are measured on.
• Property, shipping and other asset-heavy businesses, where the assets have observable market values and the question is whether the shares trade above or below them.
• Holding companies and conglomerates, where book value approximates a sum of the parts.

In each case the useful comparison is P/B against ROE: a bank at 0.8× book earning 6% on equity and one at 1.6× earning 15% may both be fairly priced.

When it misleads

• Intangible businesses. Brands, software, patents and customer relationships built internally are expensed, not capitalised, so the book value of a software or consumer-brand company bears no relation to the capital that created it. A P/B of 15× there is not a warning; it is the accounting.
• Buybacks and write-downs. Years of repurchases above book value shrink equity, sometimes below zero, producing enormous or negative multiples for ordinary businesses. The ratio has stopped measuring anything.
• Goodwill. Acquisitions add goodwill to book value, so a serial acquirer can show a modest P/B on equity that is mostly the premium it paid for other companies. Tangible book value, equity less goodwill and intangibles, is the stricter figure.
• Overstated assets. A P/B below 1 is only a bargain if the book value is real. Obsolete inventory, doubtful receivables, impaired plant and goodwill awaiting a write-down all sit in equity until they are recognised. Benjamin Graham's net-net screen, buying below current assets less all liabilities, exists because he trusted only the most liquid part of the balance sheet.
• Inflation and age. Property bought decades ago sits at cost; book understates it. Equipment bought recently may overstate what it would fetch.

The value trap article covers the pattern of a low multiple that is correct rather than cheap.

Using it in practice

Treat price to book as a question rather than an answer. Low P/B asks: is the return on equity low because the business is poor, or temporarily depressed? Is the book value real? High P/B asks: is the return on equity high because of durable advantage, or because leverage or buybacks have shrunk the denominator? Within financials, compare P/B with return on tangible equity across peers. Outside financials, prefer cash-flow measures and use tangible book as a floor rather than a target: the stock valuation guide covers the methods that do the main work, and the value stock screener article shows how a P/B ceiling fits into a rule set with a quality filter beside it. VALYSTR's Discover ranks the company universe on book, earnings and cash-flow multiples side by side, from each company's filed balance sheet.