In theory, the book value per share is what shareholders would get if a company was broken up. To look at the Price/Book Value per Share Ratio can be an easy way to pick if a company is under or overvalued. Basically the book value is Assets less Liabilities. To get the book value per share you divide the book value by the number of shares outstanding.
If shares are selling below book, that is the P/B Ratio is under 1.00, it could mean the shares are cheap or that the market thinks that the book value might be too high. Generally value investors tend to want the P/B Ratio to be 1.50 or less. If the P/B Ratio is high it could mean that the shares are overpriced. It could also mean that the market thinks the company may be worth more than the book value.
One of the metrics I use in deciding if a stock price is reasonable or not is to compare the 10 year median P/B Ratio of the company to the current P/B Ratio. I consider a stock cheap, if the current P/B Ratio is 80% or less than the 10 year P/B Ratio. If the current P/B is 120% or more of the 10 year P/B Ratio, I consider the stock expensive.
I like this test P/B Ratio stock test because this test does not use estimates. Although in theory a good P/B Ratio is 1.50 or less, it is also a very good idea to look at the relative P/B Ratio over time. Also, you should not look at any metric in isolation. I try to look at four different measures to determine if a stock price is reasonable or not.
Please note that although the book value is considered to be the break-up value of a company. However, the reality is that when a company goes into bankruptcy, what value the company has can decrease very rapidly. Generally, if a company is in bankruptcy, few people actually get any money at all. That being said Book Value can sometimes be used to give you an idea what a company is worth.
For further reading on this subject you can look at Investopedia. They have an article called "Using The Price-To-Book Ratio To Evaluate Companies". They also have another article called "Book Value per Common Share".
On my other blog I am today writing about National Bank of Canada (TSX-NA, OTC-NTIOF)...continue...
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