Investing For Beginners 2: Why can't use PB ratio for Facebook and Google
This investing for beginners video explains what is PB ratio and how to use it to analyse stocks.
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Chapters
00:00 What is PB ratio?
00:24 How to Calculate PB Ratio
01:01 How to know if a PB ratio is good
01:50 How to use PB ratio
What is a P/B ratio?
The price-to-book ratio, or P/B ratio, is a financial ratio used to compare a company's current market price to its book value. It gives some idea of whether an investor is paying too much for the net worth of a company.
net worth = assets - liabilities
How to calculate a P/B ratio?
P/B Ratio = Stock price / Book value per share or Market Capitalization / Shareholder's Equity
It can be easily found online.
It can be found directly under the financial statement's balance sheet
How to know if a P/B ratio is good?
As a rule of thumb,
Low P/B Ratio = Cheap & Undervalued
High P/B Ratio = Expensive & Overvalued
Let’s go through 3 possible scenarios.
P/B ratio equals to 1
The share price is trading at the company’s book value. We can say that the stock is fairly valued in this case.
P/B Ratio is more than 1
The share price is trading higher than the book value of the company and the share price is overvalued.
P/B Ratio is less than 1
The share price is trading lower than the book value of the company and the share price is undervalued.
How to use P/B ratio?
Like PE ratio, it is best to be compared for the same company in different periods or between companies within the same industry.
Here is a summary of averaged P/B ratios by Sector. As you can see, it varies dramatically across industries, with the lowest is Utilities and highest are Consumer Discretionary and Information Technology.
Why does it happen?
PB Ratio's following character could shed some light on it.
P/B ratio is useful ONLY for evaluating capital-intensive businesses like banks and insurance companies. And asset-based businesses, like Real estate, Utilities, Infrastructures, Plantation, and manufacturers. As most of their assets are tangible and included in the balance sheet for the calculation of PB ratio.
On the other hand, P/B ratios can be LESS useful for service and information technology companies such as Apple, Microsoft, Google, Facebook, GlaxoSmithKline, etc. As their most valuable assets are intellectual capital, people, innovation ability and digital platforms, etc. which are not captured in the book value. This generally leads to a much higher P/B ratio.
The price-to-book ratio is simple to use and it is widely available. However, it's only part of the puzzle when it comes to evaluating which stocks are undervalued.
So far we have talked about P/E Ratio and P/B Ratio.
In the next video, I will discuss Current Ratio & Quick Ratio. Both are popular metrics to analyze a company's liquidity status.
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