Price to Book Ratio: Advantages, Disadvantages

Posted in CFA by qmarks on May 1, 2010

When an analyst estimates the share price of a company, he can benefit from handful of multiples. The enterprise value to EBITDA (EV/EBITDA), the price-to-earnings (P/E) ratio, the price-to-book (P/B) ratio, the price-to-sales (P/S) ratio, price-to-cash flow (P/CF) are some of them. Each of them has advantages and disadvantages. In this post I will analyze the advantages and disadvantages of using Price to Book Ratio

Advantages of P/BV

  • Book value is a cumulative amount that is usually positive even the P/E multiple is negative because of negative earnings. Ergo P/BV can be used when P/E can not
  • Book value is more stable than EPS, so it may be more useful than P/E when EPS is volatile
  • For marked to market firm assets, P/BV is more useful the P/E multiple
  • Sometimes P/BV is useful in valuing companies that are expected to go out of business

Disadvantages of P/BV

  • First disadvantage shall come to mind through the asset value. Value of intangibles are not captured in assets, such as the brand value of Coca-Cola, or the human capital of service companies.
  • P/BV is misleading when there are significant differences in the asset intensity of production methods among the firms
  • Differences in accounting methods, such as US GAAP and IFRS can lead to different asset values. That makes the comparison harder
  • Inflation and technololgical change can cause the book and market value of assets to differ significantly. so book value is not an accurate measure of the value of shareholders investments
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