Why higher price-to-book ratio means better investment opportunities?

CFA Level I Equities
#1

Hi guys! I just read the following paragraph from a CFA book:

“ The price-to-book ratio, which is also referred to as the market-to-book ratio, provides an indication of investors’ expectations about a company’s future investment and cash flow-generating opportunities. The larger the price-to-book ratio (i.e., the greater the divergence between market value per share and book value per share), the more favorably investors will view the company’s future investment opportunities.”

I don’t understand the logic behind it. Why higher P/B ratio means better investment opportunities? Aren’t we looking for lower or even below 1 P/B ratios?

Thank you!

#2

The justified P/B is:

Justified\ P/B = \frac{ROE - g}{r - g}

Therefore, a P/B ratio greater than one indicates that investors expect ROE > r, and the higher the P/B ratio, the higher investors expect ROE to be relative to r.

Will it happen? Who knows? But it tells you what investors are expecting.

1 Like
#4

Thanks magician! I have been thinking and searching online for days for this explanation.

So appreciated.

Take care and stay safe!

#5

My pleasure.