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PB Ratio - How It Works and How Investors Can Use It

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When it comes to the stock market, sometimes you might hear the term "PB ratio" mentioned. It refers to a fundamental analysis metric that is popular among active stock traders.

This article will explain what a PB ratio is and how investors might be able to benefit from using it.

 

What Exactly Is a PB Ratio?

PB ratio (or P/B ratio) stands for Price-to-Book ratio. It's a fundamental valuation metric used in the stock market to evaluate a company's stock price relative to its book value.

It’s calculated by taking the current share price of a company's stock and dividing it by its book value per share.

The formula looks like this:

Here is a breakdown of the components of the calculation:

Current Share Price: This is simply the current price of the company’s stock at any given moment.

Book Value Per Share: This takes the book value of the company over the last 12 months (as of the company's most recent quarterly financial report), and divides it by the total shares outstanding for the company.

The company's book value can be found on its balance sheet by subtracting the company's Total Assets from its Total Liabilities. The company's outstanding shares can also be found on its balance sheet.

 

Why Does a PB Ratio Matter?

PB ratios can be seen as a metric to gauge how attractive the price of a stock is at any given time.

Book value is one way to measure the value of a company. By taking the company's assets and subtracting its liabilities, you can determine its book value, or shareholder equity. This is one of many ways to determine how much a company is worth.

If the stock price is lower than the book value per share, that signals that the stock is trading at a price that is below the company's book value. That could be a sign that the stock is undervalued.

A high PB ratio suggests that the stock price is relatively expensive compared to its book value.

The PB ratio is a popular metric among value investors, who typically look to "buy low" on solid established companies.

 

How Do You Find Stocks With Low PB Ratios?

You can find them by using our Low PB Ratio scanner. It's a free tool we offer here at Stock Market Guides. It uses our proprietary scanning technology to find stocks that have low PB ratios.

Here's how the scanner results look:

 

That tool ensures that you don't have to waste time flipping through stock profiles manually to find stocks with low PB ratios.

 

Limitations of the PB Ratio

As is often the case, making an investing decision based on a single metric without any context may not be effective. As helpful as the PB ratio might be, it has some limitations to consider.

 

Different industries have different typical PB ratios.

In terms of determining which PB ratios qualify as "low", it might be helpful to look at the PB ratios of others in the same sector.

Intangible assets are not accounted for.

Book Value does not account for intangible assets since they don't get assigned a value on the company's balance sheet. Some companies, such as software companies with a lot of customer contracts, have intangible assets that are worth quite a bit, yet they're unaccounted for in the book value calculation. Therefore, the PB ratio might not always adequately determine the valuation of a company.

 

Example of a PB Ratio Investing Strategy

For this example of a PB ratio investing strategy, we're going to look for stocks with low PB ratios and plan to hold them for up to a year.

 

 

In particular, we'll look for stocks with a PB ratio below 1. That value is considered by many to reflect a low PB ratio, regardless of industry. Simply put, it means the company's stock is valued less than its book value.

Our research suggests this simple strategy might have a track record of success.

 

Entry for the PB Ratio Investing Strategy

The entry for this PB Investing strategy will be as follows:

The entry criterion for our PB Ratio investing strategy is very simple.

Exit for the PB Ratio Investing Strategy

There are a lot of possibilities here for the exit.

For any given investing strategy, it can be helpful to define two different criteria for the exit: a profit target and a time limit.

Not everyone sets exit criteria for a long-term investment, and that's totally fine. Ultimately, you are in charge of your investments, and you can manage them any way you want. But for the purposes of this investing strategy example, we will define them:

 

1. Profit Target

We will set a profit target that would reflect a 20% gain if the position were to be sold at that price.

In other words, we will take the price we paid for the stock at entry, multiply it by 1.2 (which effectively adds 20%), and use that to set up a sell limit order as a profit target.

If the sell limit order gets filled before the time limit is reached, then our investment is complete, and we will have realized a 20% return on investment.

2. Time Limit

We will set the time limit as one year. If the stock has not hit the profit target within one year of the date of stock purchase, then we can close the trade manually at the stock's prevailing price.

 

How Well Do Low PB Ratio Investments Actually Work?

The idea of a low PB ratio investing strategy sounds nice to many people because it offers a clear, easy-to-understand way to find an investment idea.

But does it actually work? Can traders indeed generate profits from buying low PB ratio stocks?

That's exactly what our company can help answer for you, since our scanner technology has allowed us to do our own research on that precise question.

The answer is that investments based on low PB ratios are not always profitable, but for certain stocks they might indeed have a track record of success according to our backtest research.

Here is some data that shows how a proprietary low PB ratio investment strategy we created has performed historically according to backtests:

 

 

Anyone who signs up for our stock scanner service will be able to see stocks that qualify for that trading strategy in real time.

 

Learning More About PB Ratios

You can contact us any time if you would like to ask any questions about PB ratios or anything else related to the stock market.