Why is a lower P/v better than a higher P/V as compared with another co?
what are you paying for the company in terms of currency of Book Value if two companies have same Book Value - you would pay lower for a company with lower P/B. So for relative valuation - Lower P/B is better
Lower P/BV, just as lower P/E, P/S, P/CF, means that the stock is undervalued. The stock is cheaper for a given level of BV.
I guess I know its better if its lower but I dont understand why.
if a stock is trading close to book, there is hopefully a lot of appreciation to come so long as there wasent a prior catalyst to cause it to trade at a lower multiple
Stock A sells for $10 and its BV is $15. You are paying $10 for a company that could be liquidated from an accounting point of view for $15. Of course the company might have lots of debt and large litigation cases that might actually be worth $0, but still it’s one positive indicator.
Another way to look at it is what you are paying for net assets. If two companies have the same growth and risk outlooks, I would rather pay less per $ of net assets than more.
I know we just mentioned P/B, but lets say we looked at justifed p/b instead. If it was justified p/b question then a higher justified p/b is better than a lower justified p/b…at least that was my understanding…anybody thinking differently?
^^ Agreed with Investor83, all the explanations above address the “all things equal” argument and dont consider the justified P/B = 1 + (ROE-r)/(r-g) and the PV of residual income. Since this is a part of Equity and is so big, I think it is an important part to understand from a valuation of future income perspective.
In general, you just want to pay a lower price for things, all else being equal. In general you want a lower Price/anything ratio because that indicates the stock is undervalued relative to peers with higher Price/whatever ratios (all else being equal, obviously other information could mitigate the ratios)
I think the posts here are making this too simplistic for the point of the level 2 exam which is valuation. In a static environment, P/B says that at this moment, the liquidiation value of assets are B and you are paying P for them. Relating price in a static environment is not realistic with a going concern company/asset as it doesnt take into account future cash flows. Would you make the same assumption for the price of 2 bonds with par value of 1000? No you would look at the coupons and time left to maturity. I think this is more comparable than “you want to pay less”. Now if you have 2 companies with the same ROE and R then the higher P/B would be overpriced. But if one company has ROE 2X r then that one should have a higher P/B and it isnt overpriced.
The original question is: Why is a lower P/v better than a higher P/V as compared with another co? So, justified P/B is not the issue here. You always have to assume all else equal unless you are told otherwise. Is a P/E of 10 better than a P/E of 15? Yes it is.
only under the “all else equal” assumption are relative valuations good. but BV, as we know, is subject to manipulation - not booking impairments, paying too much in a buyout and having too much goodwill at the very beginning before it can be impaired, how invenotry is carried, how revenues are booked when not billed, AR not having enough write down, etc etc etc
BizBanker Wrote: ------------------------------------------------------- > I think the posts here are making this too > simplistic for the point of the level 2 exam which > is valuation. In a static environment, P/B says > that at this moment, the liquidiation value of > assets are B and you are paying P for them. > Relating price in a static environment is not > realistic with a going concern company/asset as it > doesnt take into account future cash flows. Would > you make the same assumption for the price of 2 > bonds with par value of 1000? No you would look at > the coupons and time left to maturity. I think > this is more comparable than “you want to pay > less”. Now if you have 2 companies with the same > ROE and R then the higher P/B would be overpriced. > But if one company has ROE 2X r then that one > should have a higher P/B and it isnt overpriced. I don’t agree with your statement that P/B equals only the price of the stock to liquidation value of assets, with no consideration of future cash flows. P/B intrinsically (through justified P/B or the RI model) takes into account the present value of future cash flows by justifying a higher price for the going concern vs. the value of net assets due to residual income in the future. I don’t think any of the answers above were saying that a P/B of 1.2 is always better than a P/B of 1.3. You obviously have to consider the specifics of the comparison, but when comparing two firms who you believe have equal growth opportunities, or equal risk, you can use the P/B as a relative valuation tool as the P/B should reflect the present value of excess future economic income.