» Stock Investing Basics » Price/Book Value Advantages and Disadvantages

Price/Book Value Advantages and Disadvantages

If you deduct the liabilities of the company from its assets you will get the book value of the company. In other words the book value of the company represents what the shareholders will get after the company is sold and its debts are repaid. It also represents an evaluation of the market's willingness to pay for the assets of the company. Additionally, the lower this number is the better it is for the company.

Price/book value is best applicable to companies that have many tangible assets, such as companies that possess factories and other production facilities. Additionally, price/book value is well applicable with such entities as banks and insurance companies. This is so since these financial entities possess many financial assets.

Price/book Ratio Advantages

One of the advantages of the price/book ratio is that it is easy to calculate it and understand the meaning behind the numbers. As a result the knowledge of such a ratio will greatly facilitate your comparison between stocks you target, especially those that are part of old-line industries. Price/book ratios give you an understanding of how the market values the assets as compared to the earnings it makes. What is more, price/book ratio is applicable throughout the world.

Price/book Ratio Disadvantages

On the other hand, price/book value fails to reflect intangible assets such as intellectual assets, which represent the basis of the functions of high-tech companies (e.g. Microsoft). As a result, the balance sheets of such companies fail to reflect the intellectual assets of such companies. In turn, this leads to low book values and artificially high price/book ratios.

Book value registers items at the price at which they were purchased. As a result book value doesn't reflect the current market value, which leads to a lack of precision in measurement.

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