The price-to-book-ratio is a fundamental key performance figure for the market valuation of one company. The traditional theory of value investing claims that a share is worth the money the lower the price-to-book-ratio and that a share reaches its fair value at the price of the book value. Shares are considered a good investment when the price-to-book-ratio is at 1.5 or lower.
Formal calculation for the price-to-book-ratio:
Price-to-book-ratio = (Stock market price of a share) / (book value of the company)
The book value is defined as (Equity) / (Number of shares).
Stock market price of the share: 50,00 €
Book value of the company: 55,00 €
Price-to-book-value = 50/55 = 0,91
In recent years it became common to include franchise contracts, brand names, patents and registered trademarks into the calculation of the equity of companies. As a consequence many companies show a higher price-to-book-value today compared to their historic values. Therefore finanzoo.de multiplies the price-to-book-ratio with the price-to-earnings-ratio (P/E Ratio) and compares the result to empiric figures. Values below this empiric figure reach high scores whereas higher values reach lower scores.
The FScore considers the price-to-book-value with 15%.
The book value of one company finally represents its equity. This includes for example warehouses, machinery, goods on stock and real estate. This is the reason why very often this is also considered the core value of one company. If the price-to-book-value drops below a value of 1,0 this would consequently mean that the price of one share is valued less at the stock market than the worth of the sum of all its machines, warehouses, goods on stock and real estate.
In this context a low price-to-book-value represents a limitation of the loss risk as theoretically the price of one share at the stock market will in the longterm always reach the value of its equity.
In reality the evaluation however is a little bit more complex than that. First of all, investors should keep in mind that the price-to-book-value can easily be manipulated. For example the value of real estate investments is calculated at historic acquisition values. In case that such properties can only be sold at a much lower price the balance sheet of one company would include huge imbalances. The price-to-book-ratio would be low only on paper but would be much higher in reality.
Furthermore the sole consideration of the price-to-book-ratio can fool investors especially when analyzing very young companies that are not on the market for a long period of time yet. Such companies very often are only about to build up equity. Consequently they show a much lower equity compared to older companies that already went through that process.
One might finally conclude that the price-to-book-ratio can be calculated as a key performance figure in a rather simple way and still offers a lot of input for the fundamental analysis of one company. Additionally the price-to-book-value is a very good performance figure to compare different companies and can thus be a good figure for stock picking. But for the purpose of a complete fundamental analysis more relevant key performance figures need to be analyzed. The Fscore calculation therefore includes 5 more key performance figures.