Price to Book Value

Book value is the difference between total assets and total liabilities of a company. It is also known as shareholder’s equity. Theoretically, book value would be the value of the company if it was liquidated. Sometimes intangibles such as goodwill are also subtracted from shareholder’s equity to calculate the tangible shareholder’s equity, which may represent the net worth of a company better.

The Price to Book Value is calculated by dividing the company’s price by its book value per share. This is believed to be one method to determine how the company is valued. A Price/Book ratio under 1 would suggest that shareholders could get more than $1 if the company were liquidated on each $1 of shares owned.

Sometimes the book value of a company may understate its true net worth. Say for example, Coca-Cola, whose major asset is its brand name. It is an intangible and hard to value but is probably the most important asset in the company. When Buffett closed down the Berkshire Hathaway textile operation, he sold looms (bought for $5000 apiece) for less than it took him to ship to the junkyard. In a recession, the price of assets usually fall, but the liabilities on the balance sheet do not devalue, which may crush book value. Book value may also be a poor indication of the ability of the firm to generate earnings on those assets. A growth stock may have a huge price to book value and using the P/B ratio would not be a good gauge of the company’s prospects.

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