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.

What is Earnings Per Share (EPS)?

Companies exit to make ‘Profits’ and distribute them to their shareholders, by way of ‘Dividends’ and ‘Capital Appreciation’, created out of retained earnings. Corporations draw up and present accounts after the end of every financial year, after getting duly audited, in the annual general body meeting of shareholders.  The audited financial statements also disclose the ‘Earnings Per Share’ or EPS. Is not the profit and loss statement, which along with the schedules and notes following it, just suffice? What is the need to compute and report the EPS?

Before we go into what is EPS, its significance, how it is computed etcetera, we must be clear in our minds that the corporation and its owners, the shareholders are distinct, with their own needs and interests.  While the annual financial statements, comprising the statement of profit and loss, assets and liabilities and cash flows, help the owners assess the performance of the company, they are inadequate to answer the nagging question in the minds of members, “What does it mean to me, personally?”

The statement of profit and loss focuses on the company’s perspective; what the company earned, while EPS focuses on what the shareholder earned.  EPS is profits of the company reduced to the individual share.  An investor can deduce what she earned simply by multiplying the EPS with the number of shares she owns; conversely, you get EPS by dividing the profits after tax by the total number of equity shares of the company. Lets consider the following example:

ABC Corporation’s results stood as follows: profit before depreciation, interest and tax Rs.1,000,000; depreciation 10,000; interest 5250; corporate income tax 344,600; total number of equity shares 100,000 of Rs.10 each.  The EPS is computed as follows:

	Indian Rs.
Profit before depreciation, interest and tax	1,000,000
Less:
Depreciation	10,000
Interest	5,250
Corporate Income Tax	344,600
Net Profit After Tax	640,150
Total number of equity shares	100,000
Earnings Per Share (EPS)	6.40

Suppose an individual investor own 1000 shares in ABC Corporation, the company earned for her, 1000 x Rs.6.40 = Rs.6,400.

Earnings Per Share or EPS is an important component in calculating the ‘Price to Earnings’ or PE ratio, which in turn is a key tool in value investing.