In this episode I take a look at the P/B Ratio. Learn how the P/B Ratio can help you make better investing decisions, and save you from making thousands of dollars of investing mistakes.
Also covered in this episode:
- What is the P/B Ratio?
- How to use the P/B Ratio
- Where to find the P/B Ratio
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In this episode we go back to the fundamentals. I'm going to show you an important metric that could save you thousands of dollars in investing mistakes. Hi, my name is Kanwal Sarai and welcome to the Simply Investing Dividend podcast. In this episode, we're going to cover three topics. So first we're going to look at what is the PB ratio, then I'm going to show you how to use the PB ratio and then I'm going to show you where to find that number very quickly. Let's start with our very first section. What is the PB ratio? The PB ratio simply is the price to book ratio. So what does that mean? The formula is really simple. You can see it up on the screen it is the share price divided by the book value per share. So the share price or the stock price divided by the book value per share is then going to give you the PB ratio. Now, when I say share price in this episode, or in any episode, I mean the same thing when we say the stock price. So the stock price or the share price means the exact same thing. So where do you find the share price or the stock price for any company? Well, for that you can go to any website that will provide you with stock quotes or stock prices. So Yahoo Finance, morningstar, msn Money, google Finance, barcharts, any of those sites where you can get stock prices, that's where you're going to go to look for the stock price. So let's take a look at, as an example, at Yahoo Finance, so you can type in the company name, you can search by company name or you can search by the stock symbol. So here on the screen we're looking at lows and you can see that the stock price as of this recording is $201.55. So that covers the first part of our formula, which was the stock price or the share price. Now let's take a look at book value per share, because we need both numbers. Right, you can see it on the screen. We need the share price and then we need the book value in order to calculate the PB ratio. So let's move on to book value per share. Now it's really simple. The book value is a company's assets minus its liabilities, in other words, everything that a company owns minus what it owes. Okay, so let's take a look at this fictional company here, company ABC, and I'm going to keep it really simple. We're not going to get into very complicated numbers here or complicated line items, it is simple. So let's take a look at company ABC. So first we're going to look at its assets. What does the company own so you can see it up on the screen? Here Again, we're keeping it simple. I'm sure this company owns many more things, but for now let's just keep it simple here. So let's say the building that the company owns is worth $5 million and all of the machinery in there. Let's assume this is a company that's manufacturing some products. So all of the machinery that's used inside the building is worth $1 million. The land that the building is sitting on is worth $3 million, and then all of the raw materials that they use to build their products is another $1 million sitting in the building. So what we're looking at here when we're thinking about assets is think about any company out there, whether it's an airline, whether it's phone company, for example AT&T. Right, these companies own buildings, they own equipment, they own computers, desks could be vehicles, service vehicles, cars, vans, trucks. So if those companies were to shut down today and they had to sell everything that they owned, what would that be worth? So those are all of the assets. So that's what we're looking at here In this fictional company, a ABC. You can see that the total assets if we add up everything the building, the machinery, the land, the raw materials, the total assets the company owns $10 million worth of assets. If we were to sell everything, we would get $10 million in cash, theoretically, okay. Now let's take a look at the other side, liabilities. How much money does the company owe to the bank, to lenders, to creditors, right, other or other vendors? Maybe they owe them money for different things? So again, we're gonna keep this really simple. It's a simple example here. So let's let's assume the company has a mortgage of $2 million on that property and then they have another $1 million loan that they've taken out from a bank or a financial institution. So the total liabilities today are $3 million. Now remember what I showed you earlier. We need we need to calculate the book value. So the book value, this formula is simple Assets minus liabilities. So, looking at the screen, you can probably do the math right away very quickly. So let's show that up on the screen right now. We're gonna take the assets $10 million minus the liabilities, which is $3 million we now have a book value of $7 million. So theoretically, this is essentially what the company is really worth, right? If they were to sell everything, company was to stop functioning, sell everything that they own, pay off all of their debts then that's what you're left with is the book value. So in this example, company ABC has a book value of $7 million. Now remember, in the formula we are looking for book value per share. So how do we figure that out? So let's go back to what we've already calculated Book value, assets minus liabilities is $7 million. Now what we need to figure out is how many shares does this company have out there? Right Again, we're assuming it's a public company. We're assuming it trades on the stock exchange. So how many shares do they have out there? So this is how we're gonna calculate book value $7 million book value per share. So we're gonna take the book value, divide it by the number of shares. So let's assume this company has 3.5 million shares outstanding. So if we take $7 million, divide it by 3.5 million, we can now see that the book value per share is $2. Okay, really simple. The book value per share for company ABC is $2 share. That's essentially what the company is worth if we were to sell everything and pay off its debts. So now, what about market value per share, which is basically the share price or the stock price? It all means the same thing Market value per share is gonna be the same as the share price is gonna be the same as the stock price. Now, typically, which is like 99% of the time, the share price is always going to be trading much higher than the book value per share, because there is other value that the company is bringing for sure, right? There's intellectual property that's worth something. There's the trademark that's worth something, right, and there's other things in there that are worth more than just the book value. So, in this example, let's assume that the share price today is $15 a share. Okay, now we have both of the numbers that we need to calculate the PB ratio. Remember, we start off with the share price, which we now know is $15, divided by the book value per share, which we now know is $2. We can calculate the PB ratio, so you can see the formula up on the screen. Let's go ahead and put the share price in there, so that's $15. Now let's go ahead and put in the book value per share that we just calculated, $2. So $15 divided by $2 is $7.5. And so that is the price to book ratio for this company, abc. So how do we actually use that number? What does that mean, the $7.5? Or what if the PB ratio was $10? What if it was $2? So what does that mean? So how do we use this? Okay, so this is what we just calculated just a minute ago $7.5. So what this means is to buy one share in this company, you are basically paying 7.5 times the book value per share. I'm going to repeat that again because this is important. So the PB ratio in this example is 7.5. You can see it up on the screen 7.5 times the book value per share, which is $2, gives us the share price. So anytime you're looking at the PB ratio, that's what it's telling you that you are paying, in this case, 7.5 times the book value per share for a single share. Okay, so now let's take a look at another example. We're just going to go a little bit deeper into this. So we're going to look again two fictional companies, company A and company B. Let's take a look at some numbers and then decide which company is going to be a better investment company A or company B. So let's take a look at the dividend per share. Well, look at this. The dividend per share is the same for both companies $2.50. Let's take a look at the debt. This is the debt to long term equity ratio. The debt is 25% for both company A and B. Now, of course, I'm simplifying this example. In reality, company A might have a debt of 25%, company B might be 24% or 24.6%. It's going to be close. And the same thing with the dividend per share. Some companies will pay a dividend of $2.50. Some might pay $2.52. So, again, it's going to be close. But there is a point to this example that I'm going to give you, so let's stick with it. For now. Let's assume that the dividend per share and the debt is pretty much the same, or close enough, for company A and B. Now let's take a look at the book value per share. Surprisingly, here it is also the same Company A and company B both have a book value of $18 per share. So now you still might be thinking well, I don't know if company A is a better investment or is company B a better investment, because so far all of the numbers are exactly the same. And again, in real life they'll be close enough. So they're close enough, and so we still don't know which is a better investment. Now let's take a look at the PB ratio. Company A has a PB ratio of two. Company B has a PB ratio of 11. And remember what I said earlier when you're looking at the PB ratio, let's take a look at company A. It's two. That means that for every share that you buy in company A, you are going to be paying two times what its book value is today per share. For company B, you're going to be paying 11 times what the book value is per share. So now let's take a look at the share price and you can see that company A is trading at $37 a share. Company B is trading at $198 per share. So what does that look like? Let's say you had $25,000 to invest in either company A or B. If you were to put that investment all of it, $25,000 into company A, well, given its current share price, you'd be able to buy 675 shares. Company B share price is higher, the PB ratio is higher. You're only going to be able to buy 126 shares. Now remember, as dividend investors, you get paid the dividend per share. So the more shares you own, the more money you'll make in dividends. So even though we're investing $25,000 in company A and $25,000 in company B, the investment is exactly the same in company A and B. However, company A is going to pay you much more in annual dividends than company B. So in this example you can see it up on the screen here If you were to invest $25,000 in company A, you would receive every year $1,687 in dividends. If you took the same $25,000 and put it into company B, you would receive annually $315 in dividends. So, all things considered equal, company A is going to be a better investment than company B. Why? Because the shares in company B are trading closer to their book value per share, whereas company B is way more expensive. And because it's way more expensive, you're only going to be able to afford less shares, and because you have less shares in company B, you are going to receive less dividends in company B. Now remember dividends are deposited as cash directly into your trading account, so you can spend that money if you wish, or you can reinvest it into other stocks that pay dividends, so you can grow your dividend income over time. So this is why the PB ratio is really important, and I said at the beginning of this episode that if you don't pay attention to this one metric, it could cost you thousands and thousands of dollars in investing mistakes in the future. In this example, literally, if you were to invest in company B, you would be losing approximately $1,300 a year in dividends. So to me that is a very expensive investing mistake. Again, all things considered, equal, right. There are certainly other numbers to look at. I'm going to show you that in just a minute here, but in this example, all things considered equal, company A is going to be a better investment. With company B, there is an opportunity cost and you are putting aside, leaving on the table, over $1,300 in dividends that you could have earned. So where do we find the PB ratio? That's our final topic in this episode. Here, our last section. The good news is you don't even have to calculate the PB ratio yourself, even though I gave you the formula and I showed you how to do it. You could do it if you wanted to, but you don't need to. The good news is that most sites that provide stock quotes will also give you the PB ratio, the price to book ratio. So, again, same as what I mentioned before, any site that's going to give you stock prices Yahoo Finance, google Finance, msm, money bar charts. There's lots and lots of websites out there that you can look up and get the stock prices. So in this example, we're going to go back to Yahoo Finance and we're going to look up Coca-Cola. So you can search by company name or you can search by the stock symbol, which in this case is K-O. So when you look up Coca-Cola you're going to see the stock price and you can see it up on the screen here. Then you're going to have to click on this section right here that I've highlighted on the screen statistics, and then focus down a couple of lines and you can see it right there. It says price to book MRQ, which stands for most recent quarter. That's fine. What we're looking for is the price to book ratio. So right there on the screen you can see it. It says price slash book and the PB ratio for Coca-Cola at the time of this recording is 9.31. So that's how you can look it up very quickly for any company out there and it is a good metric and an important metric to look out for. Now for us, as dividend investors, our focus is to ensure that the PB ratio is three or less Anything higher than that. The stock is going to be generally priced high, it's going to be overvalued, and we don't want to overpay for our investments. So what we look for is a PB ratio of three or less. So does this mean that you should go out and buy any stock with a PB ratio of three or less today? And the answer is no. There's a couple of more things that we need to look at. I'm going to show you what those are right now. Remember, our approach to investing is to invest safely and reliably over the long term, regardless of market conditions. Stock prices go up and down all the time, but we want to ensure that our capital is going to be not put at risk. We want to minimize the risk as much as possible and we want to maximize our gains as much as possible through dividends, dividend income and for us, dividend investors, the focus is on the dividend income every year and not the stock price. And our focus is not only the dividend income but growing that dividend income every single year, because there are companies that will automatically pretty much automatically increase their dividends every single year, and every time they increase the dividend, that's more money in your pocket. For example, coca-cola has had over 52 years of consecutive dividend increases. So imagine you've got a portfolio of stocks that all have a history and a solid track record of increasing their dividends year after year after year. So that's just going to mean more dividend income for you. So how do we invest safely and reliably? What we do is we invest in quality dividend stocks when they're priced low. So not just any stock has to be a dividend stock, not just any dividend stock. It has to be high quality, and not just at any price, but when it's priced low, as we saw in this example today, when you overpay for a stock, then you're not going to make as much in dividends. And then if you wanted to eventually sell it, if you're already overpaying for a stock, the likelihood of the stock price going even higher is pretty low, whereas if you bought it when the stock was priced low, if in the future you decided to sell, hopefully you could sell the stock for much more than what you paid for it. So how do you know, when you're looking at a company anywhere in the world, whether it's a quality stock and whether it's priced low or not? So for that I've created what I call the 12 rules of simply investing. You can see them up on the screen here. This is your checklist. You need to make sure that a company passes all of these 12 rules before you invest in it. If a company fails even one rule, skip it, move on to something else. So that's important. You want to make sure a company passes all of the 12 rules. Rule number one do you understand how the company is making money? If you don't, skip it, move on to something else. Rule number two 20 years from now, will people still need its product and services? Rule number three does the company have a low cost competitive advantage? Rule number four is it recession proof? Is it recession proof? You probably don't want to invest in that, because what's going to happen when there's a recession or a market downturn and People are losing their jobs? They are not going to go out and buy a new car. And if you invested in car companies, well, when that recession hits, those stock prices are all going to come down. We saw that with the GM in during COVID in March of 2020. They cut the dividend Right. So we don't want to invest in companies that are going to be cutting their dividend. You're investing your hard-earned money for the long term and there will be recessions in the future. There will be market downturns. So stay away from companies that are not recession proof. So that's rule number four. Rule number five is the company profitable? So we want to see a 20-year track record of profitability before we invest in any company. Rule number six does the company grow its dividend? Rule number seven can it afford to pay the dividend? Rule number eight Is the debt less than 70%? Rule number nine avoid companies with recent dividend cuts. Rule number ten Does the company buy back its own shares? Rule number eleven is the stock priced low? Rule number eleven is divided into three parts. So part one is we look at the PE ratio. Okay, if you want to go back to my episodes, I did an episode on PE ratio previously. The second part we look at the current dividend compared to the company's 20-year average dividend yield. So current dividend yield compared to the 20-year Average dividend yield. And then part three is the PB ratio. That's what we talked about in today's episode. The PB ratio must be three or less. So if a company passes all three parts, it then in rule 11, then it passes rule 11. If there's even one failure, it fails. Rule number 11 and remember what I said before before you invest in any company, make sure it passes all of the 12 rules. Okay, rule number 12 keep your emotions out of investing. So, for those of you that are interested, I've created the simply investing course. It's an online course, it's self-paced and it's got 10 video modules for you to watch. Module number one we cover the investing basics. Module two we look at the 12 rules of simply investing. Module three I show you how to apply the 12 rules Using a Google sheet. So you put all the numbers. I'll show you, step by step, how to do it. The Google sheet will then highlight which companies pass which of the rules, which companies fail which of the rules. And then, module number four, I'll show you how to use a simply investing platform. Module number five placing your first stock order. If you've never done it before, I'm gonna take you step by step on how to do that. Next module I'm gonna show you how to build and track your portfolio. Next module you're gonna learn when to sell, which is just as important as to know knowing when to buy. The next module how to reduce your fees and risk, especially if you own mutual funds, index funds and ETFs. Module number nine I'm gonna give you your action plan to get started right away. And module 10 I answer your frequently, most frequently, asked questions and I just want to mention there is also the simply investing platform. That took about two, two and a half to three years to build. It is a web application and in there we apply the rules to over 6000 companies in the US and in Canada every single day. So you just log into the platform. You can see a list of companies to consider for purchase because they pass the rules and then a list of companies to avoid for now Because they fail the rules. So I showed you the PB ratio. That's in the platform, every company 6000 companies in there. We show you the PB ratio for every single company. Now the platform is Automatically will show you which companies pass the rules, which ones fail the rules, so you don't have to filter through six thousand stocks yourself. The platform does it for you. So if you're watching this or listening to it, you may want to write down the coupon code save 10 SAV1 0. Save 10 is a coupon code that's going to give you 10% off of the simply investing course, or also you can use it for the platform and save 10% off of that as well. If you enjoyed today's episode, be sure to hit the subscribe button. Hit the like button as well, and for more information, take a look at our website. Simply investing calm. Thanks for watching you.