Retail industry stock prices as of 3/26/2021 are higher than the average stock price since the start of Q42020. Market-to-book values for many firms within the industry are trading under 3x, including CVS Health ($CVS) and Aramark ($ARMK), both of which have several billions of dollars in cash on hand. The M/B ratio compares a company’s market value to its book value. The market value of a company is its share price multiplied by the number of shares outstanding. The book value is the net assets of the company. A lower M/B ratio could mean stocks are undervalued. However, it could also mean something is fundamentally wrong with the company. The P/B ratio also indicates whether you’re paying too much for what would remain if the company went bankrupt immediately. The P/B ratio has been favored by value investors for decades and is widely used by market analysts. Traditionally any value under 1 is considered a good P/B for value investors, indicating a potentially undervalued stock. However, value investors may often consider stocks with a P/B value under 3 as their benchmark. What counts as a “good” price-to-book ratio will depend on the industry in question and the overall state of valuations in the market. For example, between 2010 and 2020 there was a steady rise in the average price-to-book ratio of the technology companies listed on the Nasdaq stock exchange, roughly tripling during that period. An investor assessing the price-to-book ratio of one of these technology companies might therefore choose to accept a higher average price-to-book ratio, as compared to an investor looking at a company in a more traditional industry in which lower price-to-book ratios are the norm.
Assume that a company has $100 million in assets on the balance sheet and $75 million in liabilities. The book value of that company would be calculated simply as $25 million ($100M - $75M). If there are 10 million shares outstanding, each share would represent $2.50 of book value. If the share price is $5, then the P/B ratio would be 2x (5 / 2.50). This illustrates that the market price is valued at twice its book value.
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