Is price-to-book ratio still a reliable method for stock valuation? 

Price-to-book value (P/BV) is derived by dividing the market price with book value per share (BV per share = shareholders’ funds/total outstanding shares of the company).  

Alternatively, some analysts may choose to use price-over-net tangible asset per share (P/NTA) instead because the NTA per share provides the total value of the assets net of all intangible assets (mainly goodwill) and all liabilities before dividing the amount by the number of shares. In this article, we will use the term P/BV to reflect the general concept of either P/BV or P/NTA. 

How to use P/BV 

P/BV reflects the number of times the share of a company is being traded versus the owner’s cost. According to Benjamin Graham’s defensive value investing method, we should target for stocks that are selling at prices below 1.5 times BV.  

In general, we may use this “1.5 times” as a basic guide, but it’s better not to treat it as a foolproof number. 

The main reason for high price with low BV is because these companies tend to reward their investors with high dividend returns. As a result, their BV always stays low but their dividend yield (DY) is much greater than fixed deposit rates or the industry average. Hence, there is no fixed multiple for this method. The appropriate multiple will depend on how we view the quality of the company’s management and its earnings potential.  

According to Warren Buffett’s “cigar butt” approach, a cigar butt found on the street that has only one puff left in it may not offer much of a smoke, meaning the so-called “bargain purchase” may not turn out to be such a steal.  

Most of the time, a company is selling at a distress level due to weak earnings prospects, and any further deterioration in earnings may deplete its remaining BV. Thus, Buffett postulated that we should buy stocks based on their earnings potential instead of their attractive BV. 

P/BV is an appropriate measure of the net asset value of firms that hold liquid assets primarily. The value of liquid asset is more definite than the real property value. Examples of such companies are those in finance, investment, insurance, and banking.  

As long as these financial institutions make enough provisions for all their bad and doubtful loans, their real asset values should be near to their BVs. As a result, we will notice that it is quite difficult to find a banking stock selling near or below its BV. Most of the time, they are trading at a premium to their BVs.