Price to Book Value: Numbers Say It All

The price to book value ratio is a basic valuation ratio to evaluate the fortunes of a company.
Price to book value ratio is one of the basic valuation ratios, one which you may hear most often after the P/E ratio. However, this ratio is not very useful in many cases, particularly at this time in the bull market.

In terms of definition, it is share price divided by book value per share. The book value per share is net worth divided by number of shares. Often, analysts adjust net worth by removing revaluation reserves. However, not many companies have revaluation reserves, so if you don’t bother about revaluation reserves, that’s fine in most cases.

The problem about book value is – it is not of much help when it is greater than one. Currently, in the BSE500 list, only 50 companies have price to book value ratio less than one. So 90% of the companies are quoting above book. When
companies are quoting above book value, it is difficult to say whether they are cheap or expensive on the basis of only this ratio. For example, Hindustan Lever has a book value of 15 at current prices. Even at its low of Rs 100 a year ago, its book value was around seven or so. Clearly, a book value of seven didn’t deter the scrip from more than doubling. This is because, in HLL’s case and in many other businesses, book value will always be significantly greater than one.

Many FMCG companies like HLL have been working with negative working capital. They also don’t have much of fixed assets. Therefore, these companies can build sizeable businesses without having to keep too much capital in the business. In other words, they don’t need to retain too much of the profits to grow. Same is the case with IT companies. Infosys has a price to book value of 11 times. IT companies also aren’t too capital-intensive. Other than investing in office buildings, they don’t need much capital. Here again, price to book value has little meaning.

This ratio has some meaning only when it is less than or close to one. When it is less than one, then it means either of two things – either the company is undervalued or the company is in a declining business. Take the case of MTNL. It has a price to book of 66%. This company has been losing customers for the last few years to private telecom players. Its sales and net profits are declining. Or take companies like ITI and IFCI. These companies have eroded their net worth and have a negative book value. Escorts is another company with its price less than the book value. This company has not done well for years in any of its businesses. So most companies quoting below book value are now companies with declining businesses and with no great future. These are companies no one wants to own. There can be exceptions. If for example, MTNL gets its act together, there may be a great upside in the stock.

Price to book value has meaning for the banking sector. This is because here, the book value (or net worth) is a key factor which determines growth. A bank needs to maintain a minimum capital adequacy ratio, which acts as a cap to growth. That is one reason why banks should not quote significantly above the book value. HDFC Bank has a book value of 3.7, which is quite high for a bank. SBI has a book value of 1.4. Quite a few banks have book value less than one; examples being Dena Bank, Bank of Maharashtra and South Indian Bank. Some of these could be worth looking at.

Sometimes, companies quote below book value if their accounts are not genuine. Some companies show bogus profits, which means that the net worth shown is not correct. Sometimes, companies have high levels of debtors and loans and advances, some of which are not likely to be repaid. If such companies don’t take a write off, then again net worth won’t be genuine. In the current list of companies quoting below book, there are some companies which may fall in this category.
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One Response to Price to Book Value: Numbers Say It All

  1. Pingback: Price to Book Value : Numbers Say It All « Value Book

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