After the “Price to Earnings” ratio, furthermost
vital is the ‘Price to Book Value’ number, hereinafter christened ‘P2BV’, which
measures the relationship between the market price and the book value of the
share, as derived from the balance sheet.
Dividing the ‘Net Worth’ of the company
by the total number of equity shares, this proportion is obtained, where net
worth includes equity capital and all reserves. Otherwise, the amount of all
liabilities owed to outsiders, other than shareholders, also labeled ‘Outside
Liabilities’, can be deducted from total assets, to obtain the number. Value of intangible assets attributable to goodwill
or brand is deducted occasionally from the net worth, or excluded from the
assets to achieve, ‘Adjusted Book Value’.
The recommended number for making prudent
investment stands less than 1.5. From the investor’s perspective, smaller the
resultant number, superior is the advantage. Often investors are able to buy
shares of wonderful companies at a fraction less than one.
Example:
XYZ Co. Ltd.’s balance sheet depicts as
follows:
|
Assets:
|
Rs.
|
|
Fixed Assets
|
400,000
|
|
Current Assets
|
600,000
|
|
Intangible Assets
|
100,000
|
|
Total
|
1,100,000
|
|
|
|
|
Liabilities:
|
|
|
Equity Share Capital
|
100,000
|
|
Reserve
|
700,000
|
|
Long Term Borrowings
|
200,000
|
|
Current Liabilities
|
300,000
|
|
Total
|
1,100,000
|
|
|
|
|
Total number of Equity Shares of face
value Rs.10 each
|
10,000
|
|
Market Price of Equity Share on
National Stock Exchange
|
160
|
Gleaned from the above information,
‘Total Book Value’ is Rs.800,000 (equity share capital, Rs.100,000+reserves
Rs.700,000), and ‘Total Adjusted Book Value’ is Rs.700,000 (total book value,
Rs.800,000 – intangible assets, Rs.100,000).
‘Book Value Per Share’ is Rs.80 (total
book value, 800,000 ÷ total number of equity shares, 10,000), and ‘Adjusted
Book Value Per Share’ is Rs.70 (total adjusted book value, Rs.700,000 ÷ total
number of equity shares, 10,000).
‘Price to Book Value’ is 2 (price, Rs.160
÷ book value per share, Rs.80), and ‘Adjusted Price to Book Value’ is 2.29
(price, Rs.160 ÷ adjusted book value per share, Rs.70).
According to accepted, value investing
norms, the ‘P2BV’ of 2 or 2.29 stand high and not worth buying the share of XYZ
Ltd., at the current market price of Rs.160, and advisable, to wait for the
price to come down, unless extremely special reasons exist to buy at a higher
price.
The closing price of the share of NMDC
Ltd., an impressive company that extracts and sells iron ore, stood at Rs.94.30. The scrip has a book value per share of Rs.81.38
and a ‘P2BV’ of 1.16. On the other hand,
Gillette India Ltd., another wonderful company, closed at Rs.4,702.50, has a
book value per share of Rs.221.81 and a ‘P2BV’ of a monstrous 20.63, ten times above
that of NMDC.
Under the circumstances, which share to buy?
The question here is not concerning quality, both remain valuable, if not
equally, nevertheless while NMDC is available at value for money price,
Gillette is too expensive.
In the current market scenario, an
investor is more likely to fare, healthy buying the shares of NMDC rather than
those of Gillette, unless the latter extraordinarily flourishes in the Indian
market and compensates the investor in an equally extraordinary fashion, which
though not impossible, is farfetched. To conclude, it is safer and wiser to
procure shares at ‘Price to Book Value’ of below 1.5, than otherwise.
