What makes a P/B ratio value consider to be healthy?

Hi, i have been reading CFA lvl 1 session 14: Introduction to Price Multiples. I have read that we can compare the market price to its book value using P/B ratio. After studying this chapter, i search online and found that a P/B ratio of less than 1 is consider a good buy and its undervalue. A P/E below 10 has a higher probability of gaining higher returns i’m trying to use what i have study in cfa and apply to real world so i can remember and understand more thoroughly what it means. However i read that on Aug 2010, warren buffet has increase his stake in walmart. From my calculations and reading its finance statements, it seems that the P/B ratio is 3.65, P/E 12.96 at the price of 49.67. Of course the income returns and operating income are positive. The numbers which are calculate are derived from the statements and i never adjusted for any fifo, life or other adjustments in balance sheet. However i did remove goodwill and intangibles from the calculation. With a P/B 3 times more than 1 and p/e above 10, whats makes him see that it is a good investment? Can anyone show me some light? Thanks for reading my post

i refuse to shed you any light…not until you tell us more about yourself.

I think the first thing you’ve got to remember is that the ratios are not independent of the quality of the company. Walmart is one of the best quality companies in the world, so you will tend to pay more for it relative to current net asset value and earnings than for an average or poor quality firm. Also consider that book value is often a poor measure of the true net asset value of a firm. The P/B observed will also vary hugely depending on industry. If a firm has few physical assets, it will be able to earn very large returns relative to its book value and consequently see a high ROE and high P/B. While a P/E of less than 10 might be considered cheap as a crude rule of thumb, it does not mean that anything over this is expensive. A P/E of 10 implies a 10% earnings yield before dividends. Walmart at 13x implies a 7.5% yield approx. Compared to current 30 year govies, that looks very attractive. I recommend you try to find some good books on investment theory. Start by searching Amazon for Warren Buffett and search through the related books from there.

Also, if the firm made a lot of acquisitions or have intangibles, P/B would be less useful.

Its a relative metrics. However it makes sense while buying back your own shares if P/B is less than one. Same is true if E/P is more than cost of borrowing, then buy more of your own with borrowed money. Otherwise someone will snatch your firm. ( Not always true unless you are consistently making money :slight_smile: ).

Historically low value (i.e. low P/B) companies have outperformed high value companies (i.e. high P/B), but this doesnt mean they are always good investments, and the high returns are usually only a return for higher risk. Although Warren Buffet is a value investor it doesn’t mean that he has to invest in companies trading on low multiples. If you have a business that has sustainable high growth with barriers to entry then that business isn’t ‘expensive’ on 12x earnings, it should be trading on 15x earnings. Good businesses deserve higher multiples. In general I would think about removing intangibles from a balance sheet. Sometimes a company doesnt need a lot of fixed capital to operate (i.e. consultancy companies only need people), in which case their people represent an intangible asset. If a company is trading below its book value, I would ask why the market believes the company isn’t worth its net asset value; most likely because the market doesn’t believe the value of the companies assets…

Thanks for sheding the light on this area, To FrankArabia(at second post) Hi, actually i’m currently in IT industry. Manage to expose to finance for the first while taking accounting at 15 yrs old. After a few yrs in IT, i realise finance is what that interests me. Therefore took CFA lvl 1 since last yr, fail twice and found that the second time i’m in band 10. taking again next coming Jun. Bcos i;m in IT industry and due to time contraints, based on my learning patterns, i need to relate those theories i read into the real world. If not i forget easily. so thats y try some of the knowledge i get in cfa text and apply some to walmart. Anyway thanks to everyone who share tis knowledge with me. going back to study derivatives. :slight_smile:

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