What is ‘Price to Book Value’?

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.