P/B Ratio and significance

The lure of the markets is so strong that an increasing number of investors come flocking with their hard-earned money. The uncertainties, the ups and downs haven't dampened their spirits and investors hope to strike it rich. The adage 'buy low, sell high' works well. So does the good advice 'invest for the long-term'. But certain technical parameters, ratios and numbers is sure to give investors a more detailed picture of the company stock they are pumping their money into. Instead of simply following the crowd, friends or financial advisors, an analysis of numbers will place you in a better position. This approach that involves simple technical analysis and research, ensures your money is not invested in the wrong places. A well-researched investment could be time-consuming. But it assures the safety of your investment, and brings in an element of predictability into the highly unpredictable volatile markets. Price-to-book ratio (P/B ratio) offers a more tangible measure of a company's value than earnings do and hence it is evaluated by most conservative investors. P/B ratio is used to compare a stock's market value with its book value. It is calculated by dividing the current closing price of the stock by the latest quarter's book value. P/B is equal to share price divided by book value per share. Let us first begin with understanding what book value is. Wondered how much a company is really worth and what is its correlation to its stock price? Book value reflects a company's worth. It can be defined as the company's assets minus its liabilities. If the company pulled its shutters, this number suggests how much would be left after all the outstanding obligations are settled and assets sold off. A company that is performing very well will always be worth more than its book value for its ability to generate earnings and growth. In essence, book value is what would be left over for shareholders if a company closes its operations, pays off its creditors, collects from its debtors, and liquidates itself. Now coming back to P/B ratio, this is a good matrix to value stocks of companies with large tangible assets in their balance sheets. A lower P/B ratio can mean that the stock is undervalued or something is fundamentally wrong with the company. This ratio gives you an idea if you're paying too much for what would be left if the company declared bankruptcy. P/B ratio is particularly useful for value investors, who are always on the hunt for low price stocks that the market has neglected. If P/B is less than one, it normally tells investors that either the market believes the asset value is overstated, or the company is faring very badly in terms of returns on its assets. P/B ratio indicates the inherent value of a company. Many investors have successfully used this to discover dormant stocks, held them over a long term and booked good profits. Though it has its own flaws, it offers an extremely easy tool for identifying clearly under or overvalued companies.