Can we compare the companies directly with the justified price multiple to see which one is overvalued or undervalued?

Can you compare the companies directly with the justified price multiple to see which one is overvalued or undervalued?

Did a question 37 from Kaplan second book mock 2 morning session the other day.

They calculated the justified P/B ratios for three firms and find out the true price with the P/B. Then, they compare the calculated price (fundamental price) with the current trading price. I wonder why cant we just use the justified P/B directly to measure which company is overvalue or undervalued?

Thanks!

Because the justified P/B ratio only tells you a number that the formula says is justified. If you dont look at the actual P/B ratios then how can you actual tell how the firm is valued? A firm may have a higher P/B value while trading way above that, while the others may be relavtively cheap by that metric.

Eh I see what you’re getting at but let me go on a quick tangent to illustrate why you normally can’t.

Imagine just using a market PE to see if a company is over or undervalued. If I said that Large Cap Growth stock had a PE of 20, would that be expensive? You don’t really know. It depends on a ton of factors. For me, the growth rate jumps out as the determining factor. So isolating a metric doesn’t really say too much (I’m simplying… I know Buffet loves P/B in and of itself).

Going back to P/B, one of the uses of the justified metrics is to get a metric that is more objective than the market. You can then compare it to the market price or valuation to see how that is reflected. If there is a big discrepancy it might give you insight into the stock being over or undervalued.