The financial metric known as the price to book ratio measures the market price per share of common stock of a company relative to the book value of each share. The price to book ratio is used to determine if a company's stock price is undervalued.
The price to book ratio can be calculated two ways:
Price to Book = Market Price per Share / Book Value per Share
Market to Book = Total Market Capitalization / Total Book Value
Generally, higher price to book ratios are preferred, since they indicate a larger market premium is being paid by investors relative to the net book value of the assets owned by the company. When this ratio falls below 1.0, analysts and investors should be warned that a problem does exist with the company, or the market is not valuing it correctly, since a share of stock is worth more than it is selling for on the market.
The price to book ratio uses information from the balance sheet as well as the current market price of the company's common stock. When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Company A's current market price per share of common stock is $88.24. Company A's balance sheet indicates total owner's equity (shareholder's equity) of $15,420,000 and no preferred shares issued. Company A has 693,000 shares of common stock outstanding. The price to book ratio of Company A would be:
= $88.24 / (($15,420,000 - $0) / 693,000)
= $88.24 / ($15,420,000 / 693,000)
= $88.24 / $22.22, or 3.97