When you start delving into the world of the stock market you will start coming across all kinds of different ratios and calculations that can help you decide which stocks are best to invest in.Â A classic example of this is the price to book ratio.
This particular ratio enables you to use two pieces of information to work out what kind of market value a particular company has.Â In this case the two pieces of information are the latest share price for that company and the book value for that share.Â To work out the figures you divide the first by the second to get your answer.
The price to book ratio can be very useful in figuring out whether you would be advised to invest in a particular company.Â If the value turns out to be quite low you may have stumbled across a company whose stock is undervalued.Â But don’t jump straight to this conclusion – it may not necessarily be true.Â It is a clue but you need to figure out what this clue is telling you.
Many industries have different price to book ratios that are typical for that line of work too.Â For example one industry may always have low price to book ratios that are completely normal for that area.Â Other industries may throw up warning flags if the price to book ratio goes as low in that area.Â It is all relative so it pays to know as much as you can about this kind of ratio.
Generally speaking though, a low price to book ratio is better than a much higher one.Â If it is too high you will find that the company may be overvalued, and that means its value will probably come down at some point to address the balance.Â This is basically what happened during the dot com boom, when many different internet companies were greatly overvalued before the bubble burst.Â A lot of people lost a lot of money as a result, and the truth is that working out the price to book ratio could have prevented some of them from losing as much.
As you can see it is a useful tool to have.Â It helps you to work out what the value of a company’s shares are, and that means you can be more secure in figuring out which ones you should invest in.
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