New Investors: How Can a Stock’s Price-to-Book Ratio Help You?

Have you ever wondered what a price-to-book ratio is and how it helps you invest? We answer those questions here, using Enbridge Inc. (TSX:ENB)(NYSE:ENB) as an example.

| More on:

When you look for stock information on a financial website, you might be overwhelmed by all of the numbers you see. What do the numbers mean, and will they help you make good investment choices? Let’s demystify one of these numbers today: the price-to-book ratio (P/B for short).

What does the ratio mean?

The ratio compares a company’s market value to its book (or accounting) value. To get the ratio, you divide the market value by the book value. Some people will use the terms market value and market capitalization interchangeably, but market value should take into account more factors, such as P/E ratios, price-to-sales ratios, and return-on-equity ratios, not just outstanding shares and stock price. Market value is supposed to help you decide the strength of a company as an investment.

Book value refers to a company’s net equity. In this case, we are looking at tangible assets (removing intangibles such as patents) minus liabilities. While market value is affected by external factors in the market, book value looks entirely at internal company operations. The ratio is also sometimes called the price-to-equity ratio.

You don’t need to pull out your math skills to figure this ratio out. Most investment sites, such as Yahoo or Google Finance, will provide the number for you. A ratio above one means the market value is higher than its book value. For example, if a stock has a P/B ratio of 1.50, the market value is 50% higher than the book value.

What does the ratio tell me?

You’re probably now thinking, Great, but what does this ratio do for me? It helps you figure out the value of a stock. Value investors look for stocks they feel are undervalued, which means they think a stock is selling below its intrinsic value. They see room for growth in undervalued stocks. Warren Buffett is probably the king of value investors.

When a value investor looks at the P/B ratio, they want to see a stock’s market value close to, or even less than, the book value. So, for value investors, the lower the ratio, the better.

P/B ratios vary depending on the industry, so if you are trying to decide if the ratio is good, look at a stock’s peers. For example, Enbridge Inc. (TSX:ENB)(NYSE:ENB) currently has a P/B ratio of 3.16. This would indicate a market value far higher than book value, which is the opposite of what value investors want to see. However, when we look at Enbridge’s peers, most of them are in the two to three range, so Enbridge isn’t out of line with its industry. Some industries, such as technology, tend to have high P/B ratios, because many of their assets aren’t adequately listed in their book values. (Items like patents and intellectual property do not to show up in book value.)

Bottom line

Generally, the lower the market value compared to the book value, the better for people looking to invest. Just remember to measure the P/B ratio against a company’s peers. And it certainly shouldn’t be the only number you look at when you consider whether or not to buy a stock. It’s just one piece of the puzzle for you to examine.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Susan Portelance has no position in the companies mentioned. The Motley Fool owns shares of Enbridge. Enbridge is a recommendation of Stock Advisor Canada.

More on Stocks for Beginners

An investor uses a tablet
Stocks for Beginners

If I Could Only Buy 2 Stocks in the Last Half of 2024, I’d Pick These

I’m looking to buy two stocks over the next month. Here’s a look at my picks and why you should…

Read more »

dividends grow over time
Stocks for Beginners

The Smartest Growth Stock to Buy With $2,000 Right Now

Do you have $2,000 to invest for the long term? These three TSX stocks have and will continue to deliver…

Read more »

The virtual button with the letters AI in a circle hovering above a keyboard, about to be clicked by a cursor.
Tech Stocks

Is OpenText Stock a Buy, Sell, or Hold for 2025?

OpenText stock has fallen in the last few years, but that could mean this top tech stock remains an undervalued…

Read more »

man touches brain to show a good idea
Dividend Stocks

3 No-Brainer REIT Stocks to Buy Right Now for Less Than $200

REITs have long been touted as some of the best dividend stocks out there if you want recurring, strong income.…

Read more »

grow money, wealth build
Dividend Stocks

3 Top High-Yield Stocks to Buy in November

If you want passive income, high yield dividend stocks are the clear choice. These are the best, and safest, out…

Read more »

Stocks for Beginners

Where will Loblaw Stock be in 5 Years?

Want a great food stock that can provide growth and income? Here's why Loblaw stock can offer that and more.

Read more »

A worker overlooks an oil refinery plant.
Dividend Stocks

3 Canadian Infrastructure Stocks to Buy Now

Infrastructure makes up everything we use, from the water we drink to the roads we drive. And these three infra…

Read more »

Sliced pumpkin pie
Stocks for Beginners

Ready to Invest With $2,000? 4 Stocks for November

Got $2,000 to start a new investment portfolio? Try these four high quality Canadian stocks for long-term wealth compounding.

Read more »