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General Issues in estimating and using price-book value ratios
Measurement
The book value of equity is the difference between the book value
of assets and the book value of liabilities.
The measurement of the book value of assets is largely determined
by accounting convention.
Book Value versus Market Value
The market value of an asset reflects its earning power and expected
cashflows.
Since the book value of an asset reflects its original cost, it
might deviate significantly from market value
if the earning power
of the asset has increased or declined significantly since its
acquisition.
Advantages of using price/book value ratios
It provides a relatively stable, intuitive measure of value which
can be compared to the market price.
Given reasonably consistent accounting standards across firms,
price-book value ratios can be
compared across similar firms for
signs of under or over valuation.
Even firms with negative earnings, which cannot be valued using
PE ratios, can be evaluated
using price-book value ratios.
Disadvantages of using price-book value ratios
Book values, like earnings, are affected by accounting decisions
on depreciation and other variables.
When accounting standards
vary widely across firms, the price-book value ratios may not
be
comparable across firms.
Book value may not carry much meaning for service firms which
do not have significant fixed assets.
The book value of equity can become negative if a firm has a sustained
string of negative earnings reports,
leading to a negative price-book
value ratio.
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