The Price to Book (P/B) Ratio is used to compare a company’s market price to book value and is calculated by dividing price per share by book value per share.
The price-to-book ratio measures a company’s market price in relation to its book value. The ratio denotes how much equity investors are paying for each rupee in net assets.
Book value, usually located on a company’s balance sheet as “stockholder equity,” represents the total amount that would be left over if the company liquidated all of its assets and repaid all of its liabilities.
Book value = Net Worth
Book Value per Share = Book Value / Total number of shares
P/B Value Ratio = Market Price per Share / Book Value per Share
Use of Book Value per Share:-
The book value per share may be used by some investors to determine the equity in a company relative to the market value of the company, which is the price of its stock.
For example, a SMG Ltd company that is currently trading for Rs. 200 but has a book value of Rs. 100 is selling at twice its equity. This example is referred to as price to book value (P/B), in which book value per share is used in the denominator. In contrast to book value, the market price reflects the future growth potential of the company
There are basically two methods to calculate the book value,
1. Liability Side Approach:
Under this approach the book value is calculated by adding The Share capital and Reserves & surplus which nothing but the Net worth of the firm.
Book Value = Net Worth (Shareholders’ fund)
2. Asset Side Approach:
Under this method we calculate the book value by subtracting the outsiders’ liabilities (Non current liabilities and Current liabilities) and the fictitious assets from the Total assets.
Book Value = (Total assets – Fictitious assets) – Outsiders’ liability
If you ask me, I personally prefer the Asset Side Approach to measure the book value.
This is because when we calculate the book value by liability side approach; we don’t deduct the Fictitious assets value.
Fictitious assets are current assets which have no market value but just created out of some miscellaneous expenditures such as preliminary expenses, loss on issue of shares, discount on issue of debentures etc.
So considering them in book value makes NO SENSE.
Now to calculate book value per share just divide Book value by the total number of outstanding shares.
That is, Book Value per share = Book Value / No. of outstanding shares