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Book Value Ratios.pdf

Book Value Ratios.pdf

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06/27/2014

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Price-Book Value Ratio: Definition

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The price/book value ratio is the ratio of the market value of equity to the book value of equity, i.e., the measure of shareholders’ equity in the balance sheet.
Price/Book Value =
Market Value of Equity




Book Value of Equity
Consistency Tests:

•  If the market value of equity refers to the market value of equity of common stock outstanding, the book value of common equity should be used in the denominator.
•  If there is more that one class of common stock outstanding, the market values of all classes (even the non-traded classes) needs to be factored in.

Aswath Damodaran

93

Book Value Multiples: US stocks

Aswath Damodaran

94

. Japan and Emerging Markets – January 2012 Aswath Damodaran 95 .S.Price to Book: U. Europe.

this can be simplified to. P0 = DPS1 r − gn   Defining the return on equity (ROE) = EPS0 / Book Value of Equity. the value of equity can be written as: P0 = BV 0 * ROE * Payout Ratio * (1 + gn ) r-gn   P0 ROE * Payout Ratio * (1 + g n ) = PBV = BV 0 r-g n If the return on equity is based upon expected earnings in the next time period.Price Book Value Ratio: Stable Growth Firm   Going back to a simple dividend discount model. P0 ROE * Payout Ratio = PBV = BV 0 r-g n Aswath Damodaran 96 .

Price Book Value Ratio: Stable Growth Firm Another Presentation     This formulation can be simplified even further by relating growth to the return on equity: g = (1 .Payout ratio) * ROE Substituting back into the P/BV equation.g n = PBV = BV0 r-g n   The price-book value ratio of a stable firm is determined by the differential between the return on equity and the required rate of return on its projects. P0 ROE . € Aswath Damodaran 97 .

low P/BV ratios and high ROE or high P/BV ratios and low ROE.Looking for undervalued securities . The firms which should draw attention from investors are those which provide mismatches of price-book value ratios and returns on equity . it is not surprising to see firms which have high returns on equity selling for well above book value and firms which have low returns on equity selling at or below book value. Aswath Damodaran 98 .PBV Ratios and ROE     Given the relationship between price-book value ratios and returns on equity.

04 2.33 2.05 2.55% 18.72% 1.62% 22.86 1.03% 28.94 3.46 2.35% 21.66% 18.99% 21.93% 19.30 2.45% 21.16% 14.91% 19.14% 31.55% 11.66% -6.84% 12.06% 36.79% 34.46% 11.74% 10.An Eyeballing Exercise: European Banks in 2010 Name BAYERISCHE HYPO-UND VEREINSB COMMERZBANK AG DEUTSCHE BANK AG -REG BANCA INTESA SPA BNP PARIBAS BANCO SANTANDER CENTRAL HISP SANPAOLO IMI SPA BANCO BILBAO VIZCAYA ARGENTA SOCIETE GENERALE ROYAL BANK OF SCOTLAND GROUP HBOS PLC BARCLAYS PLC UNICREDITO ITALIANO SPA KREDIETBANK SA LUXEMBOURGEOI ERSTE BANK DER OESTER SPARK STANDARD CHARTERED PLC HSBC HOLDINGS PLC LLOYDS TSB GROUP PLC Average Median PBV Ratio 0.82% Standard Deviation 49.17% 9.66% 24.56% 12.96 1.18% 18.54% 11.23 2.32% 1.15 2.86% 17.66 1.79% 12.36% 26.07 Return on Equity -1.59 2.73% 13.23 1.28% 20.64% 18.72 1.22% 22.95% 20.09 1.21% 35.93% Aswath Damodaran 99 .09 2.38% 21.98 2.71% 20.06% 8.50% 32.80 1.53 2.

with low risk. •  Overvalued stocks: Trade at price to book ratios above the median for the sector and generate returns on equity lower than the sector median. But what is a low price to book ratio? Or a high return on equity? Or a low risk One simple measure of what is par for the sector are the median values for each of the variables.93%). generate returns on equity higher than the sector median (11. Aswath Damodaran 100 .05). A simplistic decision rule on under and over valued stocks would therefore be: •  Undervalued stocks: Trade at price to book ratios below the median for the sector.The median test…     We are looking for stocks that trade at low price to book ratios. (2. while generating high returns on equity.82%) and have standard deviations lower than the median (21.

we ran a regression of PBV against ROE and standard deviation in stock prices (as a proxy for risk).33) R squared of regression = 79% Aswath Damodaran 101 .63 ROE 2.56) (3.68 Std dev (5.27 + 3. But what is a low price to book ratio? Or a high return on equity? Taking the sample of 18 banks.32) (2.How about this mechanism?     We are looking for stocks that trade at low price to book ratios. while generating high returns on equity. PBV = 2.

And these predictions? Aswath Damodaran 102 .

The Valuation Matrix MV/BV Overvalued Low ROE High MV/BV High ROE High MV/BV ROE-r Low ROE Low MV/BV Undervalued High ROE Low MV/BV Aswath Damodaran 103 .

Price to Book vs ROE: Largest Market Cap Firms in the United States: January 2010 Aswath Damodaran 104 .

What are we missing? Aswath Damodaran 105 .

ROE and Risk: Large Cap US firms Cheapest Aswath Damodaran 106 .What else are we missing? PBV.

Bringing it all together… Largest US stocks Aswath Damodaran 107 .

PBV Ratios – Largest Market Cap US companies in January 2012 Aswath Damodaran 108 .

Even in chaos. there is order… US Banks (Mkt cap> $ 1 billion) in January 2009 Aswath Damodaran 109 .

In January 2010… Another look at US Banks Aswath Damodaran 110 .

.Banks again. In January 2012 Aswath Damodaran 111 .

IBM: The Rise and Fall and Rise Again PBV vs ROE: 1983-2010 Aswath Damodaran 112 .

PBV Ratio Regression: US January 2012 Aswath Damodaran 113 .

21 + 0.77 + 1.PBV Ratio Regression.14 + 0.43 ROE R squared 38.90 + 0.92 Payout – 0.1% 20.56 ROE PBV = 1. NZ & Canada Europe Japan Emerging Markets Regression – January 2012 PBV = 0.2% 22.78 ROE 47.67 Payout – 0.16 Payout – 0.Other Markets January 2012 Region Australia.26 ROE PBV = 0.40 Beta + 3.76 Payout – 0.18 Beta + 5.6% PBV = 1.67 Beta + 7.8% Aswath Damodaran 114 .17 Beta + 5.

Value/Book Value = Market Value of Equity + Market Value of Debt Book Value of Equity + Book Value of Debt Aswath Damodaran 115 . both the market value and the book value can be stated in terms of the firm.Value/Book Value Ratio: Definition     While the price to book ratio is a equity multiple.

g = BV WACC .g If we replace. we get:   V0 FCFF1 /BV = BV WACC .g Aswath Damodaran 116 . consider the simple free cash flow to the firm model:   FCFF1 V0 = WACC .g Dividing both sides by the book value.(g/ROC) EBIT(1-t).we get V0 ROC .Determinants of Value/Book Ratios   To see the determinants of the value/book ratio. FCFF = EBIT(1-t) .

.Value/Book Ratio: An Example   Consider a stable growth firm with the following characteristics: •  Return on Capital = 12% •  Cost of Capital = 10% •  Expected Growth = 5%     The value/BV ratio for this firm can be estimated as follows: Value/BV = (..10 .05) = 1.12 .05)/(. Aswath Damodaran 117 . but the basic determinants will remain unchanged.40 The effects of ROC on growth will increase if the firm has a high growth phase.

Value/Book and the Return Spread Aswath Damodaran 118 .

EV/ Invested Capital Regression .January 2012 Aswath Damodaran 119 .US .

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