November 26, 2008

Buy on the Cheap (Price/Book Ratio) (Session 4)


If you made it through price to earnings ratio, price to book ratio will be a piece of cake.

What is it?

Market Price per Share
BPS otherwise known as (Book Value / Total number of Shares outstanding)

What does it tell us?

We looked at Price to Earnings in the previous section. Price to earnings showed us what we were paying for as it relates to money coming in the front door, but what about the stuff the company already owns? If you bought a company I imagine you would be interested in what machines the company owns, any buildings, or real estate even any vehicles, and also what they owe. This is what price to book ratio does for us. From our example previously of book value we come out with a book value of $250M (so after selling all of the assets off and paying the bills we have 250M) if there are 900M shares outstanding that gives us a BPS of $.28 if the stock costs $1 that gives us a Price to book ratio of 3.57.

Market Price per Share

BPS otherwise known as ((Book Value) / Total number of Shares outstanding)

$1

(($1300M - $600M - $450M) / 900M)

If the stock was $2 we get 7.2.
$2
(($1300M - $600M - $450M) / 900M)

Summary:

The higher the price to book ratio the higher we have to pay to get our hands on the assets of the company after the debts are paid. We love a low number then.

What does Graham use?

Current price should not be more than 1 1⁄2 times the book value last reported.
(P.363 the Intelligent Investor)