The Price to Book Ratio (P/B Ratio) is commonly used by value investors to find undervalued stocks in the market. The formula compares a stock’s market value (current price) to its book value (company’s assets).
Generally speaking, the lower the P/B ratio of a stock, the more undervalued it may be. The results of this financial ratio can give investors an idea if they are overpaying to own a stock. It is important to note that in some cases a low number represents a fundamental problem with the company.
How to Calculate the Price to Book Ratio
The formula to calculate a stock’s price to book is fairly simple. The ratio uses the stock’s most recent closing price by the latest quarter’s book value per share. Both of these inputs can be readily found on most financial websites.
A company’s book value per share can be calculated by subtracting total liabilities from the total assets. For a more conservative calculation, investors can also subtract intangible assets from total assets to remove items like “good will”.
P/B Ratio = (Stock Price) / (Total Assets – Total Liabilities)
Dividend Stock Calculations
As a income investor, I look for companies that offer competitive yields that have a strong history of dividend growth. While these factors are important in screening out the top dividend stocks, I am also concerned about not overpaying to own one of these companies. Using financial calculations like the price to book ratio are helpful tools for investors like me to decide a fair market value for a stock.
Let’s take a look at two different dividend income stocks and their P/B ratio.
Walgreen (WAG)
- Previous Closing Price – $33.27
- Book Value Per Share – $16.80
WAG P/B Ratio = $33.27 / $16.80
At the time of this writing, Walgreens had a P/B value of 1.98, which is fairly low compared to other dividend stocks. However, conservative value investors like Warren Buffett or Benjamin Graham prefer to buy stocks that have a value under 1.5. It is ultimately up to the investor to decide on a suitable threshold for their investments.
Aflac (AFL)
- Previous Closing Price – $44.07
- Book Value Per Share – $27.25
At the time of this writing, Aflac had a P/B value of 1.62. Compared to WAG, shares of AFL seem to be more undervalued and a better buy. However, since these companies come from different industries, it is recommended that further research be done.
Using the P/B Ratio
Used by itself, the price to book ratio is not that helpful to investors. While a low value may indicate an undervalued stock, it could also signal financial problems with the company. When the ratio is used in combination with other financial data, it becomes more powerful and helpful for investors looking for value in the market.
As a dividend investor, I have started focusing more on finding value in the market and the P/B ratio is part of that analysis. While I use other factors such as current yield, payout ratio, and P/E ratio – I don’t want to overpay for a blue chip stock. The price to book formula is one such way I can help set a fair market price to buy a stock at.
What formulas do you use to set a fair market value for a stock?