The table below lists the historical price-to-book (P/B) ratios by sector, calculated using the 500 largest US companies. It’s important to remember that the valuations of different sectors can’t be compared directly with each other using the price-to-book ratio. To evaluate whether a sector might be undervalued/overvalued, the current P/B should be compared against the sector’s historical average ratio.
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Price-to-Book (P/B) Ratio by Sector (Large Cap U.S. Companies)
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P/B ratio’s relationship with stock market returns
How closely are the historical sector specific P/B ratios correlated with stock market returns? If you calculate a simple historical correlation of the historical P/B ratios of a sector and the 3-year forward return (the total return during the period of the next three years) of the sector, you will get a negative correlation for all the sectors. This means that a price-to-book ratio higher than the historical average is associated with lower sector returns and vice versa.
However, the strength of the relationship varies quite a lot. For Utilities, Consumer Staples and Consumer Discretionary companies, the correlation is close to minus one which indicate a strong relationship, meaning that the P/B can be used as a pretty good indicator whether a sector is undervalued or overvalued. For Real Estate, Energy and Financial companies, the correlation is closer to zero which would mean that the relationship is weak and higher than average price-to-book ratio does not always mean that the sector is overvalued.
It is important to remember that the P/B ratio of one sector should not be compared directly to other sectors. It depends on the industry how important the actual assets that a company owns are for generation revenue. For many companies, intellectual capital or brand value is not captured as a part of assets but these can be the most crucial components of the firm’s performance. In order to determine if a sector could be overvalued, its current P/B should be compared to the sector’s historical average.
The weaknesses and limitations of price-book ratio are well discussed. Many investing gurus have declared the ratio close to meaningless but research has shown that shares with low P/B consistently outperforms stocks with high market-to-book value. Also, our research suggests that the ratio can be successfully used to evaluate valuation levels of certain sectors.
How the Price-to-Book ratio is calculated?
P/B ratio is calculated by dividing a company’s share price by the book value per share. The book value per share is reported on a firm’s balance sheet. The logic behind the ratio is to compare the value of a company’s assets to the price that investors are ready to pay for the company as a whole. A company with a high P/B is expected to generate more earnings with lesser amount of assets.