Sunday, 25 December 2016

Price to Book Value Ratio

Price to Book Ratio

P/BV ratio
= Market price of common stock / Book Value per share

Unless the market becomes grossly overvalued (1999 and 2000), most stocks are likely to trade at multiples of less than 3 to 5 times their book value.

There is usually little justification for abnormally high price to book value ratios - except perhaps for firms that have abnormally low levels of equity in their capital structures.

Other than that, high P/BV multiples are almost always caused by "excess exuberance."

As a rule, when stocks start trading at 7 or 8 times their book values, or more, they are becoming overvalued.

Investor Mistakes (Short-lived Growth)

So called value stocks are stocks that have low price to book ratios, and growth stocks are stocks that have relatively high price to book ratios.

Many studies demonstrate that value stocks outperform growth stocks, perhaps because investors overestimate the odds that a firm that has grown rapidly in the past will continue to do so (Short-lived Growth).

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