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Price-to-Book Ratio: Essential for Banks, Nearly Useless for Software

Valuation • Beginner Investing • 7 min

What this lesson is about

The same ratio that's a core tool for valuing a bank tells you almost nothing useful about a company whose real assets never show up on its balance sheet.

2 parts · a quick check after each · then the quiz

Part 1 of 2

Book, value, is, what’s, left, on, a, company's, balance, sheet, after, subtracting, liabilities, from, assets., It’s, the, accounting, version, of, shareholders', equity., Price-to-book, (P/B), compares, a, company's, market, price, to, that, figure:, market, capitalization, divided, by, book, value,, or, share, price, divided, by, book, value, per, share., For, some, industries,, this, comparison, is, crucial, for, valuing, the, business., For, others,, it, hardly, matters.

Banks,, insurers,, and, real, estate, companies, fall, into, the, first, category., Their, balance, sheets, largely, define, the, business., A, bank's, assets, are, mainly, loans, and, securities., An, insurer's, assets, are, mostly, investments, that, back, future, claims., A, real, estate, company's, assets, are, primarily, properties., Since, these, assets, are, financial, or, closely, linked, to, market, value,, book, value, often, reflects, real, economic, worth., That’s, why, P/B, (or, more, accurately,, price-to-tangible-book-value), has, been, a, key, valuation, tool, in, financial-sector, analysis, for, decades.

What you pay for the earningsA multiple is a number of years of profit. Move it and see how many.

Quick check

How is the price-to-book (P/B) ratio calculated?

Part 2 of 2

Insider, Angle:, In, contrast,, software, and, other, asset-light, businesses, sit, in, the, opposite, category., Their, value, often, comes, from, the, brand,, codebase,, customer, relationships,, and, engineering, talent., Standard, accounting, rules, don’t, record, that, as, an, asset, unless, acquired, from, someone, else,, which, then, shows, up, as, goodwill., This, is, why, a, fast-growing, software, company, might, trade, at, 15x,, 30x,, or, even, a, meaningless, multiple, of, book, value:, its, real, value, isn’t, found, on, the, balance, sheet.
Try, This:, Look, up, the, price-to-book, ratio, of, a, major, bank., Then,, compare, it, to, the, price-to-book, ratio, of, a, well-known, software, company., How, different, are, the, two, numbers?, Does, that, gap, make, sense, given, what, you, now, know, about, where, each, company’s, real, value, comes, from?

Quick check

Why is P/B considered especially meaningful for banks and insurance companies?

Quiz

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