Price-to-Book Multiple
The price-to-book (P/B) ratio compares market value of equity with book value of equity, the accounting net worth left after liabilities are deducted from assets. It is an equity multiple that answers how much the market pays for each dollar of recorded book equity. P/B is most useful where assets are marked close to fair value, as in banks and insurers, and least useful for asset-light firms whose value lives in brands and people that the balance sheet never records. Its natural partner is return on equity (ROE), because a firm that earns a high ROE relative to its cost of equity creates value above book and earns a P/B above one, while a firm earning below its cost of equity tends to trade below book.
Why it matters
Book value is what the accountants say the owners would be left with on paper. P/B asks how much more, or less, the market is willing to pay than that paper figure. The link to ROE is the heart of it. If a bank earns a strong return on the equity recorded on its books, that equity is worth more than its carrying amount and the stock trades above one times book. If it grinds out a return below what shareholders demand, every dollar of book equity is worth less than a dollar and the stock slips below book. The ratio is weak when the real engine of value, a brand or a research pipeline, sits off the balance sheet entirely.
Formulas
Worked examples
A bank has book equity of A$50 per share and trades at A$75. Its return on equity is 14 percent against a cost of equity of 10 percent. Read the P/B and check it against the ROE link.
P/B is A$75 over A$50, which is 1.5. That premium over book is exactly what the ROE link predicts. With ROE of 14 percent comfortably above the 10 percent cost of equity, each dollar of book equity earns more than shareholders require, so it should be worth more than a dollar in the market. A bank earning below its cost of equity would instead trade at a P/B below one. For an asset-heavy financial firm, where book equity is close to fair value, this reading is informative in a way it would not be for an asset-light software business.
Common mistakes
- ✗A P/B below one always signals a bargain. A sub-one P/B often reflects a return on equity below the cost of equity, which can be a fair price for a value-destroying business rather than a discount.
- ✗Book value equals the firm’s true economic worth. Book equity is an accounting figure at historical or carrying values and routinely omits intangible assets such as brands and intellectual property.
- ✗Price-to-book works equally well for every industry. It is most reliable for asset-heavy firms like banks and least reliable for asset-light firms whose value sits off the balance sheet.
- ✗P/B and ROE are unrelated. The two are tightly linked, since a firm earning a return on equity above its cost of equity commands a P/B above one.
Revision bullets
- •P/B is market value of equity over book value of equity
- •Book equity is assets minus liabilities, an accounting net worth
- •Most useful for asset-heavy firms such as banks and insurers
- •P/B above one when ROE exceeds the cost of equity
- •P/B below one when ROE falls short of the cost of equity
- •Weak for asset-light firms with large off-balance-sheet intangibles
Quick check
A firm is most likely to trade at a price-to-book ratio above one when
The price-to-book ratio is generally most informative for
Connected topics
Sources
- Titman & Martin, Ch. 8Titman, S., & Martin, J. D. Valuation: The Art and Science of Corporate Investment Decisions. Pearson.Covers equity multiples and the role of book-based ratios within relative valuation.
- Damodaran on relative valuationDamodaran, A. Investment Valuation: Tools and Techniques for Determining the Value of Any Asset. Wiley.Derives the price-to-book and return-on-equity relationship and its industry limits.