• The book value of equity is the accountant's measure of what equity in a firm is worth.
  • Many investors continue to believe that accountants provide not only a more conservative but also a more realistic measure of what equity is truly worth than do financial markets.
  • There are many stocks that deserve to trade at less than book value because they have made poor investments, high risk, or both.
  • It is conventional to use as updated a measure of book value of equity per share as you can get.
  • If firms report on a quarterly basis, you can use the equity from the most recent quarterly balance sheet.
  • The P-BV will increase as the expected growth rate increases.
  • The P-BV ratio will be lower if the firm is a high-risk firm and has a high cost of equity.
  • The P-BV ratio will increase as the payout ratio increases for any given growth rate.
  • Firms that are more efficient about generating growth ( by earning a higher ROE) will trade at higher multiples of book value.
  • The key determinant of P-BV ratios is the difference between a firm's return on equity and its cost of equity.
  • Low price-to-book stocks perform best when the overall market is in the doldrums, reflecting their status as defensive stocks.
  • Since book values are based upon accounting judgments, its should come as no surprise that the highest price-to-book ratios are in sectors in which the most important assets are kept off the books. E.g. R&D h higher expenses in pharma companies, brand name in FMCG companies.
  • Low P-BV stock do not look excessively risky on a beta basis since the average beta across these stocks is slightly lower than the average beta across all other stocks.
  • The transactions costs associated with buying stocks that trade at low prices is often much higher than average or high-priced stocks.
Screening method:
  1. Only stocks with P-BV ratios that were less than 0.80 to be considered.
  2. To control for risk, all firms that have betas greater than 1.5, debt-to-equity ratios (in market value terms) that exceeded 2 and annual standard deviation of the stock greater than 80% to be eliminated.
  3. To control for price level, all firms that trade at prices less than Rs. 33 to be eliminated.
  4. To screen for a minimum ROE, all firms that have ROE of less than 8% in the most recent financial year to be eliminated.

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