Using Price to Book Value to Find a Bargain

The price to book value is a valuation multiple that many investors use to find companies that are undervalued in the marketplace. This metric is fairly simple to calculate, and investors hope to be able to find companies that they can buy at a discount. Here are the basics of price to book value. 

Price to Book Value

The price to book value is a comparison of the value of the company's stock to the book value of the company. By using this, you can tell if a company is actually worth what the investors think or if the value is being inflated. At the same time, if the book value of a company is greater than the value in the marketplace, this is a sign that the company is undervalued. Investors can use this financial ratio to their advantage in order to uncover the true value of a company.

How It Is Calculated

In order to calculate the price to book ratio, you need to first calculate the book value of the company. To do this, you need to look at the company's assets and liabilities. Take the assets and subtract liabilities from that number. This will tell you the amount of equity that the company has. You would then take the book value of the company and divide that number by the total number of outstanding shares in the marketplace. This gives you a book value per share. Then you would take the price of the stock in the marketplace and divide that number by the book value per share. The number that you get would represent the price to book value. 

Example

Let's say that you had a company that had $200 million in assets and $100 million in liabilities. You would subtract the $100 million from the $200 million and come up with $100 million in equity. This is the book value of the company. The company has 10 million shares outstanding in the marketplace. You would then take the $100 million in equity and divide that number by $10 million to come up with $10 per share in book value. Then you would need to look at the value of the stock in the marketplace. Let's say that the value of the shares in the marketplace is $20. You would then take the $20 and divide it by $10 in order to come up with a price to book value of 2. 

Cautions

Even though price to book value can be a valuable metric to look at, it should not be the only thing that you evaluate. This should be only a part of your repertoire when it comes to evaluating companies. Look at the price earnings ratio, the earnings yield and many other valuation multiples before deciding if a company is worth investing in.

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