Price to book
Price against the accounting value of what shareholders own. Nearly useless for a company whose value is people and brands, and the right tool for banks and for cyclicals whose earnings cannot be trusted this year.
Chapter 19 · Advanced
price to book = market capitalisation ÷ shareholders' equity
What the market pays for each rupee of accounting net worth. The oldest multiple in use, and the one whose applicability varies most.
What book value is
Chapter 5: assets less liabilities, the residual belonging to shareholders. Share capital plus accumulated retained earnings and reserves.
It is an accounting figure, not a market one, and three features follow:
Assets are mostly at cost less depreciation, not at what they would fetch. Land bought decades ago sits at its old price.
Self-created intangibles are largely absent. A brand built over forty years does not appear; a brand bought last year does, as goodwill. Chapter 5's asymmetry.
It reflects history. Book value is the accumulated record of what was put in and retained, not a view on what the business is worth.
Why it is nearly useless for most companies
A software company whose assets are people, code and customer relationships has a small book value and may be worth a great deal. A consulting firm's balance sheet is a desk and some receivables.
For these, a price to book of 15 means nothing at all. The denominator is not measuring what the business is.
So for most modern service businesses, skip it. Chapter 17 and chapter 18 are the right tools.
Where it earns its place
Banks and financial companies. This is the main case, and it is a strong one.
A bank's assets are financial — loans and securities, carried at values close to what they are worth, and revalued regularly. Book value is a meaningful measure of the capital base, and the capital base is what limits how much a bank can lend. For a bank, price to book is the primary multiple and P/E is secondary.
It also pairs with return on equity in a way that makes both legible, which is the next section.
Cyclicals, when earnings cannot be trusted. Chapter 17's trap: a commodity producer's current earnings may be a peak or a trough, making P/E actively misleading. Book value is far steadier, so price to book gives an anchor through the cycle.
Asset-heavy businesses generally — shipping, real estate, infrastructure — where the balance sheet is a real description of the business.
Companies in trouble. When earnings are negative there is no P/E, and price to book at least asks what the assets are worth.
The relationship with return on equity
The connection that makes price to book interpretable, and it follows from chapter 16.
A company earning a return on equity equal to its cost of equity is worth roughly its book value — price to book of 1. Earn more than the cost of equity and it is worth more than book; earn less and it is worth less.
higher ROE → higher justified price to book
So price to book and ROE should move together across comparable companies, and plotting them for a set of banks gives close to a line. The useful observations are the ones off it.
High ROE, low price to book. Either genuinely mispriced, or the market doubts the book value — which for a bank usually means doubts about whether the loans are worth what they are carried at.
Low ROE, high price to book. The market expects returns to improve, or is paying for something not on the balance sheet.
The trap specific to this multiple
Price to book below 1 is not automatically cheap.
It says the market values the company at less than its accounting net worth. Three possibilities:
The assets are not worth their carrying value. For a bank, bad loans not yet provided for. For a manufacturer, plant that will never earn a return. The market is marking the book down because it does not believe it.
The returns are below the cost of capital. Chapter 9: a company earning 5% on capital that costs 11% is worth less than its book, correctly, and growth makes it worse.
It is genuinely mispriced. Possible, and the rarest of the three.
A company has traded below book for a decade usually because it deserves to, and the work is establishing which of the three applies rather than assuming the last.
Tangible book value
Deducting goodwill and intangibles gives tangible book value, which is the conservative version and the standard one for banks. It strips out the premium paid on past acquisitions — chapter 5's point that goodwill is a record of a decision rather than something saleable.
The point
Price to book compares price with accounting net worth, which is history at cost and excludes self-built intangibles — so it is nearly meaningless for service businesses. It is the primary multiple for banks, and the right anchor for cyclicals whose current earnings cannot be trusted. Below 1 usually means the market doubts the assets or the returns, not that the shares are cheap.
Check yourself
4 questions. Every answer is explained afterwards, including the ones you get right — guessing correctly is not the same as knowing. Score 70% or more and the chapter is marked done.
Question 1 of 4
0 of 4 answered. You can submit with questions unanswered — they simply score zero.
Now do it with your own numbers
For three banks, plot price to book against return on equity. The relationship should be close to a straight line. Any bank far off it is either mispriced or has a problem with its assets.
Higher ROE justifies higher price to book, because the same book is producing more. A low multiple on a high ROE invites the question of whether the book value is real.