Price-to-book (P/B) ratio

Key takeaways

• P/B equals share price divided by book value per share, where book value is common shareholders' equity excluding preferred stock and non-controlling interest.
• Price to tangible book value (P/TBV) removes goodwill and other intangible assets, and is the more conservative measure used for banks.
• The justified P/B is (ROE - g) / (r - g): a company earning a return on equity above its cost of equity deserves to trade above book.
• P/B and ROE must be read together; a low P/B with a low ROE is not cheap, it is priced for its returns.
• P/B loses meaning for asset-light and intangible-heavy businesses, companies that have bought back large amounts of stock, and companies with negative equity.

The formula and what book value means

Book value is shareholders' equity as reported on the balance sheet: total assets less total liabilities. Because the P/B ratio compares it with the market value of common shares, the book value used must belong to common shareholders only. Preferred stock is subtracted at its carrying or liquidation value, and non-controlling interest (the equity of subsidiaries owned by outsiders) is excluded. Most balance sheets show equity attributable to owners of the parent separately, which makes the second adjustment easy.

Book value per share (BVPS) divides common equity by the number of common shares outstanding at the balance sheet date. For P/B work, use the actual shares at that date rather than a weighted average, and use a diluted count if options and convertibles are material.

Book value is a historical cost measure for most assets, adjusted for depreciation, impairments and the retained profits of the business over its life. It is not an estimate of what the assets would sell for or what the business is worth. That gap between accounting value and economic value is exactly what the ratio measures.

Tangible book value

Tangible book value removes goodwill and other identifiable intangible assets from common equity. Goodwill arises only when a company acquires another business for more than the fair value of its identifiable net assets, so two otherwise identical banks can have very different book values simply because one grew by acquisition and the other grew organically. Removing goodwill puts them on the same footing.

For banks, tangible book has a second justification. Regulatory capital rules deduct goodwill and most intangibles from common equity tier 1 capital, because those assets cannot absorb losses in a crisis. Investors therefore treat tangible book value per share (TBVPS) as the closer measure of the loss-absorbing capital each share owns, and quote price to tangible book (P/TBV) alongside, or instead of, P/B.

Some analysts leave out mortgage servicing rights or capitalized software when computing tangible book, and some deduct the related deferred tax liability. The definitions vary between companies, so check each one or rebuild the figure from the balance sheet.

Why P/B anchors banks and insurers

A bank's balance sheet is its business. Loans, securities, deposits and borrowings are financial items whose carrying values are reasonably close to economic value, with loan loss allowances and fair value measurement bringing them closer. The difference between an industrial company's book value and its worth is dominated by assets the accounts leave out; for a bank that difference is much smaller, so book value is a meaningful starting point.

Equity is also the binding constraint. Regulators require banks to hold capital in proportion to their risk-weighted assets, and insurers must hold capital against the risks they underwrite. Growth in lending or premiums therefore requires growth in equity, and a bank's earning power is directly tied to its book. Enterprise value is rarely used for these companies because debt and deposits are raw material for the business rather than financing, so there is no clean separation between operating and financing liabilities.

Insurers add one wrinkle. Their large bond portfolios are often carried at fair value with unrealized gains and losses recorded in accumulated other comprehensive income (AOCI), a component of equity. When interest rates rise, bond values fall and book value drops, even though the insurer intends to hold the bonds to maturity and the liabilities they back are not remeasured in the same way under every framework. Analysts often quote P/B excluding AOCI for that reason. IFRS 17 and the US GAAP targeted improvements for long-duration contracts have changed how some liabilities are measured, reducing but not removing this mismatch.

The justified P/B: return on equity is the driver

The link between P/B and profitability comes from the same Gordon growth model that underlies the justified P/E. Start with P0 = D1 / (r - g). Next year's earnings equal return on equity times opening book value, E1 = ROE x B0. Sustainable growth equals the retention ratio times ROE, so the payout ratio is 1 - g / ROE. The next dividend is therefore D1 = ROE x B0 x (1 - g / ROE) = B0 x (ROE - g). Substitute and divide by B0.

The result is one of the most useful relationships in valuation. If a company earns exactly its cost of equity, ROE equals r and P/B equals 1.0x regardless of growth: growth adds no value because each dollar retained earns only what investors could earn elsewhere. If ROE exceeds r, P/B is above 1.0x and growth increases it. If ROE is below r, P/B is below 1.0x and growth reduces it, because the company is reinvesting at returns below what shareholders require.

Rearranging gives an equivalent form that makes the logic explicit: P/B equals one plus the present value of the excess return, (ROE - r), per dollar of book, growing at g. This is the residual income model in multiple form.

Reading P/B against ROE

Because ROE drives the justified multiple, a P/B ratio on its own says little. A bank at 0.7x book is not necessarily cheap; if it earns 6 percent on equity against a 10 percent cost of equity, the table above says it should trade at about one third of book. A bank at 2.0x book is not necessarily expensive if it sustainably earns 16 percent.

Practitioners therefore plot P/B against ROE for a peer group. Companies sitting well below the line fitted through their peers trade at a lower multiple than their profitability suggests, and deserve investigation: either the market doubts that the ROE is sustainable, or the credit quality of the book is worse than it appears, or the stock is genuinely mispriced.

The relationship can also be run backwards to extract the market's implied cost of equity, which is useful when the analyst trusts the ROE and growth estimates more than any cost of equity estimate.

When P/B is meaningless

Asset-light and intangible-heavy businesses. Under both US GAAP and IFRS, internally generated brands, customer lists and most research spending are expensed rather than capitalized. A software company or a consumer brand that built its franchise internally carries almost none of its most valuable assets on the balance sheet. Its P/B will be very high and tells you mainly that accounting leaves those assets out.

Large buybacks. When a company repurchases shares at a price far above book value per share, it reduces book equity by the full amount paid. Book value can shrink toward zero while the business is unchanged, which sends both P/B and ROE to extreme levels. The same happens with large special dividends and with leveraged recapitalizations in private equity, where a portfolio company borrows to pay a dividend to its sponsor.

Negative equity. Accumulated losses, or distributions and buybacks larger than cumulative retained profit, can push book equity below zero. The P/B is then negative and has no meaning, even though the company may be highly profitable and valuable. A franchisor with steady royalty income that funds large buybacks with debt can operate for years with negative book equity for exactly this reason.

Distorted book values. Large impairments, acquisition accounting that marks up the target's assets, very old assets carried at depreciated historical cost (for example land bought decades ago), and differences between US GAAP and IFRS measurement choices all make book value a poor comparison across companies.

Using P/B in practice

For a bank, the workflow runs from ROE to multiple. The analyst forecasts sustainable ROE, often on tangible equity (return on tangible common equity, ROTCE) if P/TBV is the chosen multiple, estimates the cost of equity and growth, and checks where the current P/TBV sits relative to the justified figure and to peers on a P/TBV versus ROTCE chart. Numerator and denominator must match: pair P/TBV with ROTCE, and P/B with ROE.

For bank M&A, acquirers and their advisors track tangible book value dilution: the reduction in the acquirer's TBVPS caused by paying a premium over the target's tangible book, and the number of years of added earnings needed to earn it back. That earn-back period is a standard part of how such deals are presented.

Outside financials, P/B remains a useful secondary check for capital-intensive businesses and for spotting when a company trades close to or below the value of its net assets, which can indicate distress or an opportunity for an asset-based buyer. It is rarely the primary multiple.