On a schweser q-bank question I calculated a P/B ratio of 1.80 for subject firm. In the question it says, “Based on a justified P/B ratio compared to a P/B ratio (based on market price per share) of 1.60.” Determine if the firm is most likely…overvalued/undervalued/correctly valued
correct answer per schweser is undervalued. Why isn’t it overvalued if you are calculating a P/B higher than the market P/B ratio?
because when working out if it’s undervalued or overvalued you look at where it IS trading (the market p/b ratio) compared to where it SHOULD be trading (justified p/b ratio)
the justified p/b is higher, therefore the stock is undervalued
thanks for good explanation Kiakaha. SHOULD BE TRADING…
Assume the bookvalue is 10. Market price will be 16(1.6*10) while the justified price will be 18(1.8*10). This is why the p/b ratio of 1.6 is undervalued.