P/B ratio (price to book)

What it is

P/B compares what the market charges for a share with what the balance sheet says each share owns. A P/B of 1 means you pay exactly book value. A P/B of 3 means you pay ₹3 for every ₹1 of book value.

You can also work it out for the whole company: market cap ÷ total book value gives the same answer.

How to read it

P/B makes most sense when assets are close to their real value and drive profit, as in banks and finance companies. Their assets are mostly loans and investments, so book value is a fair measure of what the business has.

P/B should be read with ROE. A company that earns 20% a year on its book value deserves a higher P/B than one earning 8%. A high P/B with a high, steady ROE can be reasonable. A high P/B with a low ROE is hard to justify.

Limits

For software, consumer brands and other asset-light businesses, book value hides most of what makes the company valuable. Their P/B often looks very high and tells you little.

A low P/B is not always cheap either. A bank with large hidden bad loans may trade below book because the market expects those loans to eat into book value.

Reading P/B with ROE

Bank X trades at ₹300 with book value per share of ₹150, so P/B = 2. Its ROE is 16%. Bank Y trades at ₹90 with book value of ₹100, so P/B = 0.9. Its ROE is 6% and bad loans are rising. Y looks cheaper, but it earns far less on each rupee of book value and that book value may shrink.

Common mistakes

• Calling any P/B below 1 a bargain without checking asset quality.
• Using P/B to compare an IT company with a bank.
• Reading P/B without ROE next to it.

A share costs ₹400 and its book value per share is ₹160. What is the P/B ratio?

1. 2.5
2. 0.4
3. 240