hello everyone hi welcome to the channel of wallstreetmojo friends today we
are going to learn a tutor on price to book value ratio see the price to book
value ratio as you can see it is the most important ratio used with the
relative valuations and it is usually used along with the ratios like p/e
ratio PCF EV/Ebitda so you can see most applicable for identifying stock
opportunities in financial company especially in banks
so in this tutorial we are going to discuss the nuts and bolts of price to
book value ratio let's begin the first and the foremost thing what is price to
book value ratio see the price to book value ratio is one of the a relative as
I told you to valuation the relative valuation the ratio tools that is used
to measure the stock valuation the price to book value compares the current
market price of the share with its book value as calculated in the balance sheet
so the price to book value ratio is equal to we'll say the price per share
divided by the book value per share so this is the case price per share divided
by the book value per share see over here refer this book value or is equal
to your shareholders value and
shareholders value is basically your equal to your net worth got it
so they all are one in the same book value per share shareholders value all
are one in the same and just expand for you and net worth they all are same now
if the price price to book value ratio is let's say 5x then what does it mean
that you implies that current market price of the share is trading at five
times the book value as obtained from the balance sheet now let's do some
price to book value ratio calculation let's apply this price to book value
formula to compute this Citigroup PB ratio first we require Citigroup's
balance sheet and you will download that in the 10k
report and let's see how the ratio has been calculated can you see this table
see in this table what you what is visible to you is that the stockholders
equity details are their totals citigroup's your equity holding is there
and you can see the number of shares so from the above table it is visible that
221 857 million in 2015 and to10 185 million in 2014 right see both the
details and currents pardoning , corresponding
common stock numbers is three zero double nine point four eight million
right shares in 2015 and three zero eight three in 2014
citigroup's book value will be the amount of the shareholders equity
divided by the total number of shares in both the cases 2015 and 2014 so the
price of Citigroup as on 4th march was 42.83 right so in that
scenario the citigroup's price to book value ratio is going to be 42.83
which is your price divided by the book value 71.57
which gives you 0.5983 and 0.6282
over here asset over here asset is equal to
liabilities plus shareholders equity which is a very simple accounting that's
the accounting rule so shareholders equity a book value is going to be your
asset - liability its just the changes it's just the change of the
variables in the equation now let's learn about the price to book
value ratio of the software company see in this section basically we will see
that how PV of the software company is calculated whether it makes sense for us
to apply PV ratio for valuing software companies see the case study under
consideration here we are going to take as Microsoft so the key observation from
the Microsoft balance sheet is that the Microsoft has
high amount of high amount of cash that is the first thing
second this is the first and the foremost thing second is that the
Microsoft property plant and equipment is less than 10% of the or you can say
it is less than the 10% of the total asset of total assets and its inventory
is as low as compared to the asset size so next is your inventory inventory is
inventory is basically less than as compared to its asset size and the
last is the goodwill and intangible assets that is the intangible assets
they are greater than the tangible assets so intangible assets are greater
than the tangible assets you can say with the general understanding of the
software company's balance sheet we have we look into the historical PV ratio of
some of the internet companies let's have a look can you see this over here
we have couple of fur things like you know the price to book value ratio of
face book price to book value ratio of CD CD access that is in the orange color
over here then of Google and Microsoft so this are all the details that you
have that is available what you can see what are the key observations over here
so it can be noted that the price to book value ratio is generally higher for
software companies and we note for the above company's price to book value
ratio is higher than above 4 to 5 X so the primary reason for higher price to
book value ratio is the low tangible assets as compared to the total assets
and the value derived from the above may not be correct numbers to look at in the
internet and these software companies may may have the higher amount of
intangible assets and therefore the the book value as seen in the Microsoft's
balance sheet ok please note that due to this reason we do not use the price to
book value ratio ratio as a valuation ratio for companies that have low amount
of the tangible book value ratio that is having low tangible assets right
additionally this companies are a high-growth companies in most cases
where we can play or alternate measures like p/e
ratio we can use a PEG ratio and so on and so forth other sectors where you
will find this higher price to book value value ratio and cannot apply PB
ratio are like Internet companies internet companies like Amazon you have
JD that is just I'll you have Google
then you have Alibaba and so on and so forth there FMCG company where this can
also be used like Colgate then you have a Procter & Gamble P&G you have Walmart
and you have your next as Cadbury right so this are the industry in which it can
be used now let's analyze for the automobile companies as noted from the
you know PB ratio is not the right valuation multiple for internet
companies in this section let's evaluate you know basically if it makes sense for
the automobile companies or not we'll take an example of General Motors over
here can you see this current assets the detail of the total assets what are the
key observation based on this see the general motor have a higher proportion
of the tangible assets over here and as a person is the total assets which is 30%
the General Motors asset includes basically inventory equipments you can
say inventories the general motor assets includes over here inventory capital and
operating leases and other assets right since intangible
asset is much lower over here which is close enough to less than 3% in this
particular case and the balance sheet contains a higher proportion of the
tangible assets we can apply the price to book value ratio as a valuation proxy
let's see the graph of the same you can see the graph of this over here one of
the key highlights see automobile company generally have a price to book value
ratio greater than 1 this normally happens because the asset book value
ratio tend to underestimate the replacement value over here we have the
price to book value ratio of general motors for TM and so for and so forth so
you can say even though we can apply PB ratio as a proxy to for automobile
company valuation it is still noted that primary valuation tool for such capital
intensive sectors however you may find some analysts taking into consideration
into comparables table the other capital intensive sector where PB ratio can be
used like industrial forms like Siemens General Electric BASF Bosch etc and oil
companies like a PetroChina then you have Exxon Mobil and you have
Royal Dutch Shell BB so on and so forth now why PB ratio is used in banking by
one single question why PE ratio is used in banking see from the above we have
noted that you know the PB ratio cannot be applied to Internet and software
companies however we can still apply this ratio as a proxy for capital
intensive companies like oil and gas so we can apply over there right so let us
now look at if the price to book value ratio makes sense for the financial
sectors now let us look at the balance sheet of the Citigroup and see some
details regarding the same can you see the details over here the investments
loan deposits or they all are in dollar related see the key observations over
here that the banks have the assets and liability which are periodically
mark-to-market and as it is mandatory under regulation so the balance sheet
value represents the market value unlike the other other industry where the
balance sheet represents the hist cost of assets and liabilities so bank
assets include investments in government bonds high-grade corporate bonds or
municipal bonds along with commercial mortgage or postal loans that are
generally expected to be collectible below graph over here you can see you
know it gives over here it gives a quick comparison of the historical book value
of JPMorgan UBS Citigroup and Morgan Stanley now why the price to book value
ratio can be used to value banking stock because since the banking assets and
laminate is a periodical mark-to-market their assets and liability represents
the fair or the market value hence the P B ratio can be used for valuing the
banking stocks C under ideal conditions the price to book value ratio should be
close enough to one though it would not be surprising to find that you know the
P to B ratio is sometimes less than one and for Bank with a large amount of the
non-performing assets so it is possible to find P P to be ratio above one with
significant growth opportunities due to say that its location because it is
desirable merger candidate or because of its use of technology in banking now my
next question is that you know how to use this P B ratio for valuation so you
know we'll start with the table that we we have used above C assuming that the
comparable company list relevant come competitions and important financial
numbers like you know prize market cap Book value etcetera
now can you guess which is the cheapest and the most expensive Bank from the
table that I'm going to show you I'll give you a hint C take into
consideration both the historical P B ratio in the forward PB ratio so which
is the cheapest Bank the cheapest Bank over here is AAA Bank its
historical price to book value ratio is close enough to 0.5 X and the in its
forecast is 0.6 and 0.7 in 2016 and 2017 however I feel that there is a catch
here the book value is declining you know each year and the forward PB ratio
may increase further so the declining book value ratio can be
due to limited growth opportunities or maybe UT forecasted losses for me Bank
BBB over here may be safe but given its book
value is growing and you can say that it's PB ratio is closer to 1x
in the future so which is the most expensive bang see there can be two
manga under consideration for the most expensive CCC and EEE over
here looking at the book value of the number of EEE you can say that it
seems that they are experiencing some losses each year and thereby leading to
a decrease in the book value however Bank CCC over here is showing an
increase in the book value okay 65 75 and 85 in the future thereby making
it very safer bit I think I will refrain over here to EEE bank as
compared to CCC due to the reason above so finally what are some
limitations of the price to book value ratio see the limitations of price to
book value ratio book value only takes into consideration the tangible value the
tangible value of the firm intangible economic asset like human capital is
intangible assets are not taken into consideration in PB ratio second the
effect on the technology of great intellectual property inflation etc can
cause the book to market value as it would differ significantly okay and the
third important point is that the accounting policies that are being
adopted the accounting policy that are been basically adopted by the management
can have a significant impact on the book value for example the straight-line
method was his accelerated depreciation method it can change the net property
plant equipment valued drastically and additionally you can say that business
model can also lead to difference in the book value so a company that outsource
is production will have a lower book value and a company that outsource of
production will have a lower book value of the asset as compared to the company
that produces goods in-house so I hope you have learned the ratio of price to
book value ratio and you've got a great insight regarding the same thankyou
everyone
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