If you’re invested in a banking share, you need to know about the P/B multiple (Price-to-Book). In this article, we recap what it is and what is the magic figure that investors need to keep in mind.
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So what is the P/B multiple?
The P/B multiple is the ratio of a company’s stock price to its book value per share, which is calculated by dividing the market capitalization of a company by its total assets minus intangible assets and liabilities.
Why is it used to value banks?
The Price to Book (P/B) ratio is often used to value banks as compared to other multiples because of the unique business model of banks. It helps investors determine how much they are paying for a bank’s tangible assets such as cash and other financial instruments.
Other multiples used to justify non-financial business’ performance may not be useful for banks. Take our beloved Enterprise Value to Earnings before Interest, Taxes, Depreciation and Amortization (EV/EBITDA) for instance. EV/EBITDA wouldn’t make sense because Interest is the core of a bank’s earnings!
You also have to keep in mind that a bank’s assets may not always be readily converted into cash (at least not the sum of them). So when valuing banks, it is important to look at their tangible assets in order to understand their true worth.
The P/B ratio allows investors to determine how the market perceives a particular bank relative to its book value, which is usually composed of hard assets such as deposits and loans. Furthermore, this ratio takes into account any liabilities that may be associated with a particular banking institution.
By using P/B instead of other multiples such as EV/EBITDA, investors can better assess the value of a bank’s tangible assets and liabilities in order make informed investment decisions.
Hang on, what about P/E (Price to Earnings) – isn’t that useful. Perhaps more than EV/EBITDA, but it still doesn’t tell the full story because earnings is only part of the equation when it comes to the stability of banks.
P/E cannot accurately reflect the true value of a bank, as it cannot measure the potential value that lies in these physical assets such as loan and mortgage portfolios. Additionally, P/E ratio looks only at current dividend payments or expected future earnings, whereas P/B ratio looks at both these aspects in addition to taking into account the physical assets.
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1 is the magic number
When a bank has a P/B of 1, it means that the market price of its shares is the same as its book value. When it is greater than one, the price is greater than its book value. When it is less than one, the bank’s market price is lower than its book value.
A P/B ratio of less than 1 could be an indication that the stock is undervalued and may be a good buying opportunity for investors. It may also be indicative of negative sentiment towards the company or sector, meaning that investors are wary about investing in the stock due to potential risks such as weak performance or poor management.
However, it should not be assumed that just because a bank has a P/B ratio of less than 1 that it is necessarily undervalued, as other factors such as quality of earnings and future growth prospects should also be taken into account before investing.
These principals apply vice versa when a bank’s P/B is greater than 1. This means that its market value is higher than the book value of its total assets. This could be an indication of the company’s potential for growth and profitability, as the market is valuing the company more highly than what its assets are worth.
In other words, investors are expecting the bank to generate greater profits in the future, which can be achieved through expansion and investments in new opportunities.
Alternatively, it could also be an indication that the stock is overvalued compared to its underlying fundamentals, meaning that investors may want to take caution when purchasing shares in this company.
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