What is the price-to-book ratio and how do you calculate it?

Q. What is the price-to-book ratio and how do you calculate it?

The price-to-book ratio compares the stock market value of a company with the value of its assets. It is used by some investors as a rough-and-ready way to spot undervalued stocks because a company whose assets are worth more than the combined value of all its shares could be a bargain.

Any listed company has a ‘market value’ or ‘market capitalisation’, which is simply the total value of all its shares at the current share price. It is calculated by multiplying the share price by the number of shares that the company has issued.

A company’s book value is the value of all its assets minus the value of all its liabilities (its ‘net assets’). These values are calculated by the company’s finance department and checked annually by its independent auditors, as is required by the law. They are then published in the company’s annual report.

Assets include ‘tangible’ assets such as buildings, land, machinery and stock, as well as intangible assets such as patents and other ‘intellectual property’ (IP). Another intangible asset you will also see often is ‘goodwill’. This can be an awkward concept to grasp but is in essence an attempt to capture what a company is worth beyond its identifiable assets. It is normally used when one company has taken over another.

How do you calculate the price-to-book ratio?

The ‘price’ of the company is very easy to determine: it is the market value, which can be found in numerous places online. You can also calculate it yourself, as mentioned above, by multiplying the number of shares in the company by the share price. Both figures are available on, among other places, the Fidelity website; for example, on Fidelity’s ‘key stats’ page for Tesco you can find an up-to-date share price and see that the retailer has 7,038.93m shares in issue.

Calculating the book value is a little more involved. We need to find the company’s most recent annual report and accounts, then go to the section in the accounts headed ‘balance sheet’ or sometimes ‘financial position’. This is a list of all its assets and liabilities. Be sure to find the balance sheet for the group, not for any of its individual subsidiaries or for the parent company alone, without the subsidiaries. When we are dealing with the entire group – the parent company plus all its subsidiaries – you will sometimes see the various financial statements (the income statement, balance sheet, cash flow statement etc) described as ‘consolidated’.

The balance sheet will give the total values of the company’s assets and liabilities but, as ever in investment, things can get complicated. It is common for businesses to divide both their assets and liabilities into ‘current’ and ‘non-current’ totals. Broadly speaking, the latter are permanent while the former can fluctuate throughout the year. For example, non-current assets include land and property, while current ones include stock, the value of invoices issued but not yet paid and cash in a bank account. Examples of non-current liabilities include outstanding bonds, whereas current ones include the value of bills received from suppliers but not yet paid.

A worked example

Let’s work out Tesco’s price-to-book ratio.

At the time of writing its market value is £20.8bn. To find its book value, we go to the most recent annual report and accounts, for the year to 24 February 2024, and find the balance sheet on page 131. Helpfully, Tesco has stated the ‘net assets’ figure – assets minus liabilities – so we don’t need to do any sums. It gives the ‘net assets’ figure as £11.7bn.

We divide £20.8bn by £11.7bn to arrive at a price-to-book ratio of 1.8 times.

How to use the price-to-book ratio

At first sight, Tesco’s p/b ratio of 1.8 could be interpreted as saying that the shares are expensive: you pay £1.80 for each £1 of its assets. But most people would accept that Tesco is more than simply its buildings, land and other assets: its loyal, long-standing customers and its reputation are also worth something, yet these things cannot be isolated and given a value on the balance sheet.

On the other hand, if a company simply owned land or other assets ‘passively’ (if it did no trading and had no customers) and was valued at 1.8 times the value of those assets, many analysts would question its value. As ever, if you want to assess the value of a company thoroughly, you need to delve into the detail.

Some investors and analysts prefer to ignore the value of intangible assets on a company’s balance sheet, on the basis that these assets may be difficult or impossible to sell. While this may be true in the case of, for example, goodwill, other intangible assets such as patents could be sold for handsome sums in some circumstances. Equally, while land will often find a ready buyer, certain tangible assets might be harder to sell. Imagine if a business has had a piece of machinery custom-made for a task that no competitor performs: that machinery might fetch little more than scrap value if sold.

Then there is the question of depreciation. Companies tend to reduce the value of assets (other than land) in each successive year, typically according to a formula. But the figure arrived at may not represent the actual sum that the asset would fetch on the market.

Finally, remember that while the market value figure used to calculate the price-to-book ratio will be up to date, the book value will date back to the day on which the accounts were compiled, which could be several months in the past.

All these factors should be borne in mind when p/b ratios are used as a yardstick of value.

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