The Importance of Book Value

by Charles Rotblut, CFA

Multiple studies have shown that price to book value (P/B) is the most effective valuation measure in determining a stock’s performance. Although the price-earnings ratio (P/E) is considerably more popular, buying at low price-to-book multiples leads to better returns.

Book value is the theoretical value of what a company’s net assets are worth. It is also referred to as equity. In theory, book value is equivalent to the amount of cash shareholders would receive if all of the company’s debts, both short-term and long-term, were paid off and all remaining assets were sold. Its compelling use as a measure of valuation can be explained in one statement:

No quality company should sell for a price equivalent to or less than its theoretical liquidation value.

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Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/charlesrotblut.


Discussion

Cyril from North Carolina posted over 2 years ago:

Can someone tell me what a good rule of thumb is for max/min share price to book value?

Thanks

cssjrice@bellsouth.net


Charles from Illinois posted over 2 years ago:

Cyril - Regarding book value, I consider price-to-book multiples above 4 to be excessive. My preference is that the price-to-book ratio be below 2.0, though I will accept a higher price/book ratio if the company is well-managed and is financially sound. I'd rather pay a little more for a good company, then buy a stock just because its valuation appears low. Price-to-book ratios that are near or below 1.0 can be indicative of a good bargain, but you need to fully research the company. Make sure it is profitable, generates cash, well-run, financially sound, has a history of growth and is reasonably expected to grow earnings in the future. Some companies have low valuations because they are not well-run and/or their future profitability is questionable. Therefore, while there is no minimum price-to-book ratio, you want to do a thorough analysis of the stock.--Charles Rotblut


Richard from Ohio posted over 2 years ago:

Well costructed, informative article. Thanks.


Richard from Ohio posted over 2 years ago:

Well costructed, informative article. Thanks.


Daniel from Alabama posted over 2 years ago:

Great article, thanks for explaining the details of price-to-book ratio so clearly.


Andrew from Illinois posted over 2 years ago:

Good reminder,and basically so logical, perhaps more obvious to those AAii members who ran their own businesses (or run)


Fernando from Florida posted over 2 years ago:

"No quality company should sell for a price equivalent to or less than its theoretical liquidation value." Does that mean that any company selling at a P/B<1 is a bargain , or is no good? Also, the P/B ratio is not static, it changes over time. So, if the company's P/B ratio is momentarily <1, would that mean that it is a dog for ever? Might this statistic be useful for trading, buying a stock when the P/B ratio is lower than, say 1, and selling when it is higher?
Thanks.


Charles from Illinois posted over 2 years ago:

Fernando, it depends on the company. Take a look at the financial statements and the business model. If the company doesn't have too much debt, generates positive cash flow, is both currently profitable and likely stay profitable, and should grow profits in the future, then it is a bargain at a very low price-to-book ratio. -Charles Rotblut


Ed from Washington posted over 2 years ago:

Excellent article Charles. I do have a couple of questions. Frequently I find that companies that sell at a low price to book value ratio have a lot of Goodwill and Intangible Assets. These assets frequently have little or no liquidation value. When determining book value do you make adjustments for assets like these? What about Fixed Assets? Some companies have a large percentage of equity tied up in machinery and equipment. This equipment may have little or no value if it needs to be liquidated.


Vern from California posted over 2 years ago:

Great article, thanks for explaining the pro and con aspects. I include this factor in analysis of a stock for purchase or to sell in addition to the evaluation included in SMART -1 discribed in website lifetimestrategies2009.com


Charles from Illinois posted over 2 years ago:

Edward, I do look at intangibles in proportion to shareholder equity. My preference is to see monetary or tangible assets equating to a large part of shareholder equity. It does depend on the company, however (e.g., The name "Coca-Cola" has significant value.) Fixed-assets are tougher, because there can be buyers, especially for equipment such as CNC machines. I've always just used the recorded value, because any other number would be a guess on my part. The same types of dilemmas exist with accounts receivables and inventory, which is why I describe investing as messy, instead of exact. -Charles Rotblut


Alan from Pennsylvania posted over 2 years ago:

I am disappointed that there was no mention of the fact that stocks that trade around book value normally have low ROE's. Looking at a universe of stocks that say have ROE's of 15-25% you will find all of them at a 2-5 times book. On the otherhand if you look at stocks at the 3-7% ROE range , you'll see the price around book value or less. The ROE determines how a price is in relation to bkk...same as the profit margin vs. price to sale ratio.....the higher the margin the higher the psr etc..


Jeffrey Hayes from Colorado posted 10 months ago:

Is there anyplace easy to find a price to book ratio for stocks that are not on the passing stocks or portfolio right now?


Charles Rotblut from Illinois posted 10 months ago:

Hi,

The stock quote page on AAII.com provides the price-to-book and other ratios on thousands of stocks.

On the home page of AAII, type in a ticker right below the market chart (upper right-hand side) and click "Go." Then click on "Company" and then "Key Ratios"

-Charles


Bruce from posted 8 months ago:

"Multiple studies have shown that price to book value (P/B) is the most effective valuation measure in determining a stock’s performance. Although the price-earnings ratio (P/E) is considerably more popular, buying at low price-to-book multiples leads to better returns"

I believe that Fama and French found price to book was more effective than price-earnings. If I remember correctly, they also found that price to book wasn't good, if earnings were negative.

However, not everyone has come to the same conclusion. "What Works on Wall Street" by James P. O'Shaughnessy came to a different conclusion, as did "Quantitative Value" by Wesley R. Gray and Tobias E. Carlisle.

Please correct me if I'm wrong.


Bruce from posted 8 months ago:

http://www.aaii.com/journal/article/low-price-to-sales-ratio-stocks

The above is a link from an AAII article that disagrees with the conclusion that P/B is the most effective valuation measure.


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