P/b ratio definition and p/b ratio explained in simple terms

In one of my earlier posts I have explained what is the p/e ratio and the eps. Similar to the pe/ ratio is the p/b ration. P/b ratio is the ratio which is known as the price to book ratio.

It is calculated by dividing the current price by the book value per share. For stock market for beginners this ratio to be learnt is a must for good stock picking

What does it signify?

A low p/b ratio is a sign that the stock is undervalued and that this stock should be worth a lot more.

This book value is calculated based on the actual assets on the company’s books minus the actual liabilities.

Now there is a way to look at it is that if the p/b ratio is low then the company is not returning good earnings on its assets which means it is undervalued and you should check the reason for this before you buy the stock. The second way to look at is that the asset value on the balance sheet is wrong and that will mean that either the management is trying to do some jugglery or the company made some wrong decisions. In each case you should not be buying the stock.

Again this may work well in some industries and in some industries it may not as the tangible assets are not even there in the big IT companies or the software firms. Think Google(GOOG)

That is why as is the norm with all the ratios you need to make sure that you take them with a pinch of salt and treat them as indicators and not the ultimate tool to make buying decisions.

As far as the stock market terminology goes this definitely is there at par with all other terms like p/e ratio and ROE and RONW. Each of them is an indicator for performance which necessitates further investigation to find out the real gem in these stocks.

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