Rohan Das

(1) We have explored the uses and limitations of the Price-to-Earnings (P/E) ratio and the Price/Earnings-to-Growth (PEG) ratio. Now, it is time to delve deeper into another key valuation metric: P/B (Price / Book Value per share) It can also be understood as (Market Cap / Book value)

(2) Book Value represents the net worth of a company, calculated as Assets – Liabilities. In simple terms, it is the amount of money allocated to shareholders as reflected in the balance sheet.

(3) Book value or net worth consists of Equity Capital – The initial funds raised from shareholders through the issuance of equity shares (Face value). Reserves & Surplus – Includes retained earnings, share premium, capital reserves, and revaluation reserves Retained Earnings – Profits that are reinvested in the business instead of being distributed as dividends Share Premium Account – The excess amount received over the face value of shares during issuance

(4) When a company gets listed, the net worth (book value) trades at premium or discount based on the return generated by the company and its perception and then it known as Market cap of the company. P/B (Market cap / Book Value) represents the Premium/Disc. at which the Net worth of the company is trading in the market.

(5) How to Use P/B ratio effectively: Identifying Undervalued Companies: Suppose a company consistently generates a Return on Equity (ROE = Net Income / Book Value) of approximately 15%, while the return on a fixed deposit (FD) an investor is getting around 7.5% In an ideal risk-free world, the company's market capitalization would double relative to its book value, resulting in a Price-to-Book (P/B) ratio of 2x. Summary If P/B < (ROE/FD rate), stock can be considered as undervalued from P/B perspective 🚨 A company trading at P/B less than 1 should not always be considered as undervalued. If ROE for the company is less than the prevailing FD rate, it should trade at discount to the Book value

(6) Analysing the impact of a Loss or Bad Debt: Any loss incurred by a company impacts its Book Value, as all profits and losses are ultimately attributed to shareholders in the form of Net Earnings (Net Income). Consider below for a company Mcap: ₹1,200 cr. Book value: 400 cr. P/B = (1200/400 = 3x) If a company incurs a bad debt of ₹100 crore, its market capitalization can decline by an amount equivalent to Bad Debt × Price-to-Book (P/B) Ratio. Given a P/B ratio of 3, the potential decline in market capitalization would be ₹100 crore × 3 = ₹300 crore This approach is Very useful for Banks / NBFCs.

(7) Common Misconception: Many investors mistakenly assume that a ₹100 crore bad debt should lead to a ₹100 crore reduction in market capitalization. However, they overlook the crucial role of the P/B ratio, which amplifies the impact on valuation.

(8) Conclusion: The P/B ratio is a powerful valuation tool, but it should be used alongside ROE and other financial metrics to make informed investment decisions. It helps in: • Identifying undervalued stocks. • Understanding the market perception of a company’s book value. • Assessing the impact of losses and bad debts on valuation

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