HPCL, IOCL, Oil India, SAIL, ONGC, Canara Bank, Bank of India, Bank of Baroda. Spot something common?
Of course they are all PSUs.
They all also have a Price to Book Ratio of Less than 1.
What is the Price to Book Ratio?
Let’s talk about the Price to Book Ratio. Book Value, the denominator, is the value as per the company’s balance sheet, that the shareholders should get as of today, if the company were to shut down.
Book Value is defined as Share Capital + Reserves and Surplus.
You can also think of it as Assets Minus External Liabilities. Basically, if you close the firm today, sell all assets, repay all external liabilities, then what is left should be book value.
And if you don’t shut the company, and the company has a positive future, then the market value should be over and above this book value. The bare minimum an investor should get is book value, assuming the company does not generate any value in the future.
The price to book value ratio is the ratio of the Market Cap to the Book Value.
What happens if Price to Book is less than 1?
Assume a company has a market cap of Rs 800 Crore, and Book Value of Rs 1000 Crore. Shouldn’t you buy this company at Rs 800 crore, Close it down, sell all its assets, repay external liabilities, and be left with Rs 1000 crore? In others words, a straight arbitrage of Rs 200 crore?
But the devil lies in the detail. What if you can’t buy the firm? What if you can’t sell the assets at their reported value?
Read the company names in the first line again. All PSU companies. You cannot buy them completely, atleast not easily. Even if you are able to buy, you won’t be able to close the business down. And even if you manage to do the same, the market may not trust the balance sheet of some of these atleast (Remember the NPAs of PSU Banks).
The book value does not reflect this. And that is why, the market does not give them the value as per the book value. You won’t see this ratio lower than 1 for Infosys, or HUL, or Titan.
For PSUs however, P/B can remain below 1 for far too long. Use this ratio carefully there.
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