Valuation Ratios: Price/Book Value BOOK VALUE is a company's assets minus its liabilities. It's accounting jargon for what would be left over for shareholders if the company were sold and its debt retired. The price/book ratio measures what the market is paying for those net assets (also known as shareholder equity). The lower the number, the better.
Price/book was a lot more popular in the age of smokestacks and steel. That's because it works best with a company that has a lot of hard assets like factories or ore reserves. It's also good at reflecting the value of banks and insurance companies that have a lot of financial assets.
But in today's economy many of the hottest companies rely heavily on intellectual assets, such as patents, trademarks — even their employees' collective brains — that don't appear on the balance sheet. That's why high-tech outfits like Cisco Systems have relatively low book values, which give them artificially high price/book ratios. The other drawback to book value is that it often reflects what an asset was worth when it was bought, not the current market value. So it is an imprecise measure even in the best case.
But the price/book ratio does have its strengths. First of all, like the P/E ratio it is simple to compute and easy to understand, making it a good way to compare stocks across a broad array of old-line industries. It also gives you a quick look at how the market is valuing assets vs. earnings. Finally, because assets are assets in any country, book-value comparisons work around the world. That's not true of a P/E ratio since earnings are strongly affected by different sets of accounting rules.