How is P/BV calculated?

P/BV is a valuation ratio and is arrived at by dividing the market price of a share with the respective company's book value per share.

Now, book value is equal to the shareholder's equity (share capital plus reserves and surplus). Book value can also be arrived at by subtracting current liabilities and debt from total assets.

For the banking and finance companies, book value is calculated as 'share capital plus reserves minus miscellaneous assets not written off. This formula then takes care of the bank's NPAs and gives a correct picture.

If one were to take a look at Infosys' consolidated balance sheet for FY04, as mentioned above, book value will be arrived at as adding Rs 333 million (equity capital) and Rs 32,163 million (reserves and surplus), which equals to Rs 32,496 million.

Conversely, when we deduct 'preference share in subsidiary' and 'current liabilities' from 'total assets', we shall arrive at a similar figure. Now, by dividing this book value (Rs 32,396 million) by the issued equity shares of the company (264.8 million), we would arrive at the book value per share figure, which is Rs 122.3.

This will be our denominator for calculating the P/BV for the Infosys stock, which currently stands at 13.5x.

P/BV figures for companies in the services industries like software and FMCG are high as compared to those of companies in the sectors like auto, engineering, steel and banking.

This is because companies from the sectors like software and FMCG have low amount of tangible assets (fixed assets etc.) on their books and, as such, the P/BV may not be a correct indicator of valuation. On the other hand, old economy sectors like auto and engineering have large balance sheets, i.e., they have a large amount of fixed assets and investments.

As such, P/BV is a good indicator of measuring value of stocks from these sectors.

What does P/BV indicate?

P/BV is a good metric to value stocks of companies in the capital-intensive industries like engineering, automobiles and banks, which have large amount of tangible assets in their books (balance sheet).

If a company is trading at a P/BV of less than 1, this indicates any or both of the two:

A high P/BV indicates vice versa, i.e., markets believe the company's assets to be undervalued or that the company is earning and is expected to earn in the future a high return on its assets.

Book value also has a relationship with the 'Return on Equity' of a company. In fact, book value can also be termed as equity (equity capital plus reserves and surplus). As such, for a company that earns a high return on equity, investors would be ready to give the stock a high P/BV multiple.

What does P/BV fail to indicate?

• P/BV indicates the inherent value of a company and is a measure of the price that investors are ready to pay for a 'nil' growth of the company. As such, since companies in the services sectors like software and FMCG have a high growth component attached to them, P/E and not P/BV is a right measure of their valuations.

• P/BV should not be used for valuing companies with high amount of debts. This is because high debt marginalizes the value of a company's assets and, as such, P/BV can be misleading.

We hope this article was able to throw some light on the concept of P/BV and its relevance from an investor's viewpoint.

The ratio has its shortcomings that investors need to recognise. However, it offers an easy-to-use tool for identifying clearly under- or over-valued companies.

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