Price-to-book (PB) ratio explained: how to use it for Indian banking and asset-heavy stocks

How PB ratio is calculated and what it measures

Price-to-book ratio = Market Price per Share divided by Book Value per Share. Book value per share = (Total Shareholders Equity minus Preference Share Capital) divided by the number of equity shares outstanding. If a bank is trading at 600 rupees per share and its book value per share is 300 rupees, its PB ratio is 2. This means investors are paying two times the accounting net worth per share, implying an expectation that the bank will generate returns on equity significantly above its cost of capital.

The PB ratio is most meaningful for asset-driven businesses where book value closely approximates economic value - banks, insurance companies, asset management companies, metal manufacturers, and utilities. For technology or consumer brand businesses, where the most valuable assets are not on the balance sheet (brand, intellectual property, software), book value significantly understates economic value, and PB ratios of 10 to 40 are common without implying overvaluation.

The ROE-PB relationship: the Graham-Dodd framework

There is a mathematical relationship between justified PB and return on equity. If a company's cost of equity (the return shareholders require to justify holding the stock) is 12 percent, and the company consistently earns a return on equity of 20 percent, it should trade above book value because it compounds wealth faster than the cost of holding it. The theoretical fair PB can be approximated as (ROE minus growth rate) divided by (cost of equity minus growth rate) - a simplified form of the Gordon Growth Model applied to book value.

Practically, this means banks with high and consistent ROE (above 15 percent) command PB multiples of 2.5 to 4 in Indian markets, while banks with low ROE (8 to 10 percent) trade at or below book value. When a bank's ROE is above its cost of equity, each rupee of retained earnings creates more than one rupee of market value, justifying a PB premium. When ROE is below cost of equity, the bank is destroying value with each rupee retained, and the stock correctly trades below book.

Sector-specific PB benchmarks in India

Indian private sector banks with strong ROE profiles (HDFC Bank, Kotak Mahindra Bank, Axis Bank during good cycles) have historically traded between 2 and 5 times book. Public sector banks have historically traded at lower PB multiples (0.5 to 1.5) due to lower ROE, governance concerns, and higher NPAs. PSU banks trading below book value are not automatically cheap; they are pricing in the structural ROE deficit.

Infrastructure and capital goods companies with long asset lives and low ROE often trade at 0.5 to 1.5 times book. Real estate developers trade at PB below 1 during sector downturns when inventory write-downs are possible. Steel and metals companies are often valued on PB relative to their replacement cost per tonne of capacity. Fast-moving consumer goods companies and pharmaceutical companies - both with significant intangible asset value from brands and IP - routinely trade at 5 to 20 times book, which is appropriate given their ROE profiles of 20 to 40 percent.

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