Investing in Philippines: Fundamental Side: Price-To-Book Ratio

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Sunday, July 15, 2012

Fundamental Side: Price-To-Book Ratio



I am catching up with all the analysis to equip you with your trade decisions. Again I am reminding you that you shouldn't compute for all these ratios to come up with your decision. You got to choose a few to base your buy or sell decisions. 

I checked my blog and so far PE or Price-to-Earning ratio is only valuation ratio I have discuss(click here to see this post). Valuation simply means knowing how much is a stock as compared to some basis.

Price-to-Book or sometimes Price/Book is a ratio that measures how much investors are willing to pay for the net worth of the company. Investors are looking at the larger picture when they use this ratio as basis. 

To compute this ratio we need the stock's market price and the stock's book value by simply dividing the company's net worth(Assets minus Liability) or Stockholder's Equity by shares outstanding.


 Now how can this ratio help us in our stock investing or trading decisions?

This ratio reflects how investors see how much should the assets be valued in case such will be sold and thus they are willing to pay for it at such price because they perceived or see that such will be more valuable in the future. 

As a rule of thumb a Price-to-Book value below one is undervalued thus seen as good opportunity to buy while a value above one may indicate that the stock is overvalued and thus not worth your investment for the moment.

On the other hand we should not easily jump into a stock with a low Price-to-Book ratio. We should always check the actual financial health of the company by looking at its Balance Sheets. A company's net worth might be over inflated due to assets reflected are not reported at historical prices meaning old prices as they are acquired. Theses assets might have already lost their values and thus making net worth over ending up into a lower P/B ratio.



 


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