P/B Ratio

What is Price to Book Ratio?

The Price to Book (P/B Ratio) measures the market capitalization of a company relative to its book value of equity.

 Widely used among the value investing crowd, the P/B ratio can be used to identify undervalued stocks in the market.

Price to Book (P/B Ratio)

How to Calculate Price to Book Ratio (P/B)?

The price to book ratio, often abbreviated as the “P/B ratio”, compares the current market capitalization (i.e. equity value) to its accounting book value.

Market Capitalization → The market capitalization is calculated as the current share price multiplied by the total number of diluted shares outstanding. 

Book Value (BV) → The book value (BV) on the other hand, is the net difference between the carrying asset value on the balance sheet less the company’s total liabilities. 

The book value reflects the value of the assets that a company’s shareholders would receive if the company was hypothetically liquidated (and the book value of equity is an accounting metric, rather than based on the market value.

For the most part, any financially sound company should expect its market value to be greater than its book value, since equities are priced in the open market based on the forward-looking anticipated growth of the company.

If the market valuation of a company is less than its book value of equity, that means the market does not believe the company is worth the value on its accounting books. Yet in reality, a company’s book value of equity is seldom lower than its market value of equity, barring unusual circumstances.

Price to Book Value Ratio

Price to Book Value (P/B) Ratio

Price to Book Ratio Formula (P/B)

The price to book ratio (P/B) is calculated by dividing a company’s market capitalization by its book value of equity as of the latest reporting period.

Price to Book Ratio (P/B) = Market Capitalization ÷ Book Value of Equity (BVE)

Or, alternatively, the P/B ratio can also be calculated by dividing the latest closing share price of the company by its most recent book value per share.

Price to Book Ratio (P/B) = Market Share Price ÷ Book Value of Equity Per Share

What is a Good Price to Book Ratio?

The norm for the P/B varies by industry, but a P/B ratio under 1.0x tends to be viewed favorably and as a potential indication that the company’s shares are currently undervalued.

While P/B ratios on the lower end can generally suggest a company is undervalued and P/B ratios on the higher end can mean the company is overvalued — a closer examination is still required before any investment decision can be made. From a different perspective, underperformance can lead to lower P/B ratios, as the market value (i.e. the numerator) should rightfully decrease.

P/B Ratio < 1.0x → A sub-1.0x P/B ratio should NOT be immediately interpreted as a sign that the company is undervalued (and is an opportunistic investment). In fact, a low P/B ratio can indicate problems with the company that could lead to value deterioration in the coming years (i.e. a “red flag”).

P/B Ratio > 1.0x → Companies with P/B ratios far exceeding 1.0x could be a function of recent positive performance and a more optimistic outlook on the company’s future outlook by investors.

The price to book ratio is more appropriate for mature companies, like the P/E ratio, and is especially accurate for those that are asset-heavy (e.g. manufacturing, industrials).

The P/B ratio is also typically avoided for companies composed mostly of intangible assets (e.g. software companies) since most of their value is tied to its intangible assets, which are not recorded on a company’s books until the occurrence of an event such as an acquisition

PEG Ratio

What is a PEG Ratio?

A PEG ratio, or Price/earnings-to-growth ratio, draws the relationship between a stock’s P/E ratio and projected earnings growth rate over a specific period.

This metric can provide a much more informed view of a stock in relation to its earning potential.Therefore, for more fundamental analysis, the PEG ratio is crucial.

How to Calculate PEG Ratio?

It denotes the ratio between a stock’s P/E ratio and its projected growth in earnings. It shall be noted that the P/E ratio, thus considered for PEG ratio is the trailing version and not the forward P/E ratio.

Therefore, the PEG ratio formula is written as:

Price/earnings-to-growth = (Market price of stocks per share/EPS) / Earnings per share growth rate

A PEG ratio is both grounded in objective information and is forward-looking – a factor that lends more credibility to the metric.

Example: Company A recorded earnings worth of Rs.24 lakh in FY 21 – 22. The market price of its share at that time was Rs.10, and it had a total of 3,00,000 outstanding shares. Its EPS witnessed a 2% growth over the last year and is projected to grow by 2.5% for the next year.

Therefore, its EPS, as per the records of FY 21 – 22, is Rs. 8 (2400000 / 300000).

Ergo, P/E ratio = 10 / 8 = 1.25

Hence, PEG ratio = 1.25 / 2.5 = 0.5

To find such growth rate projections, investors can refer to such a company’s own announced projections. They can also make use of estimates published by analysts at their website.l ok

How to Interpret PEG Ratio?

The P/E ratio denotes the rupee amount a shareholder needs to pay for a particular stock for earning Re. 1 of its income. Therefore, when simply basing comparison among stocks on their P/E ratios, a low value is more lucrative compared to higher values.

For instance, assume there are two stocks – stock A and stock B. The former exhibited a P/E ratio of 20, and the latter had a ratio of 25. In that case, the former would be a more reasonable investment avenue.

However, when the aspect of a projected growth rate is factored in, it might tip the scales. Let’s consider the above example of stock A and stock B. Estimations present an EPS growth rate of 18% for stock A, while for stock B it is 30%.

In that case,

PEG ratio stock A = 20/18 = 1.11

PEG ratio stock B = 25/30 = 0.83

From these values, it can be concluded that while stock A had a lower P/E ratio, the market still overestimated its earning potential. In the case of stock B, even though it had a higher P/E ratio, it is still trading at a discount when considering its future income projections.

In other words, stock A is overvalued, and stock B is undervalued. However, to what extent a stock is undervalued and overvalued, as per PEG value, varies from one industry to another. Therefore, inferences should always be in the context of industry, company type, etc.

PEG Ratio equal to, above, and below 1: What does it mean?

A PEG ratio of 1 denotes equilibrium. This equilibrium is between the perceived value of a stock’s worth and its earning potential. For better understanding, take a look at the following PEG ratio analysis.

For instance, if a company has a P/E ratio of 25 and its earnings growth rate is also projected as 25, then it means that the market has correctly perceived its value. 

On that note, a PEG ratio above and below 1 would imply that the market has wrongly perceived such stock’s value. In case the PEG ratio of a stock is above 1, it means the market has overestimated its worth in relation to its earning potential.

For example, let’s assume that stock A has a P/E ratio of 24 and an EPS growth rate of 20%. Therefore, its PEG ratio would be 24/20 = 1.2. It says that the market is currently overestimating such a company’s projected earning potential by 20% and thus, it is overvalued.

In case the PEG ratio of any stock is below 1, it means that the market has underestimated its value in relation to its projected earning potential.

For instance, let’s consider the hypothetical stock A mentioned above. If its P/E ratio remains unchanged and its EPS growth rate is revised at 15%, then its PEG ratio would come to be 0.8. It means that the market is underestimating its earning capacity by 20%, and thus, it is undervalued. 

However, there are other inferences to PEG ratios that are above and below 1. A PEG ratio above 1 could mean that investors consider its EPS growth rate inaccurate or the stock might have heightened demand due to other related factors.

Similarly, a PEG ratio below 1 could also mean that investors consider the projected growth rate to be inaccurate, or it might imply a lower demand for that stock due to other relevant factors.

What is th Equity Multiplier?

 Shareholders Equity/Equity multiplier

The term equity multiplier refers to risk indicator that measures the portion of a company's assets that is financed by shareholders' Equity rather than by debt.

The equity multiplier is calculated by dividing a company's total asset value by the total equity held in the company's stock. 

A high equity multiplier  indicates that a company is using high amount of debt to finance its assets.

A low equity multiplier means that the company has less reliance on debt.

The equity multiplier is also known as the leverage ratio or financial leverage ratio

Companies with a higher debt  burden will have higher debt servicing cost, which means that they will have to generate more cash flow to sustain a healthy business.

A low equity multiplier implies that the company has fewer debt-financed assets. That is usually seen opposite because it's debt servicing costs are lower.

Equity multiplier = Total Assets /Total Shareholders Equity.

In general, lower equity multipliers are better for investors but this can vary between industries and companies with particular industries. In some cases, a low equity multiplier could actually indicate that the company cannot find willing lenders or it could also signal that company's growth prospects are low.

On the other hand , a high equity multiplier is not always sure sign of risk. High leverage can be a part of an effective growth strategy especially if the company is able to borrow more cheaply than its cost of equity

What is Loan -to -Deposit Ratio

 The loan- to- deposit ratio is used to access a bank's liquidity by comparing a bank's total loans to its total deposits for the same period

To calculate the loan-to- deposit ratio, divide a banks total amount of loans by the total amount of deposits for the same period.

Typically the ideal loan- to- deposit ratio is 80% to 90%. A loan- to-deposit ratio 100% means a bank is funding all its loans from its deposits. This is not good. This hampers bank's liquidity.

Dr Sucheta Dalvi

Provisioning Norms for Advances and Loans in Banks as per RBI Rules

   PROVISIONING NORMS AS PER RBI GUIDELINES

1 Norms for Provisioning on Loans & Advances

1.1   In conformity with the prudential norms, provisions should be made on the non-performing assets on the basis of classification of assets into prescribed categories   

(i) Loss Assets

(a) The entire assets should be written off after obtaining necessary approval from the competent authority and as per the provisions of the Co-operative Societies Act/Rules. 

 If the assets are permitted to remain in the books for any reason, 100 per cent of the outstanding should be provided for.

(b) Regarding an asset identified as a loss asset, full provision at 100 per cent should be made if the expected salvage value of the security is negligible.

(ii) Doubtful Assets

(a) For Unsecured -Provision should be for 100 per cent of the extent to which the advance is not covered by the realisable value of the security to which the bank has a valid recourse should be made and the realisable value is estimated on a realistic basis.

(b)For secured - In regard to the secured portion, provision may be made on the following basis, at rates ranging from 20 per cent to 100 per cent of the secured portion depending upon the period for which the asset has remained doubtful:

Tier I Bank 

Period for which the advance has remained in the ‘doubtful’ category	Provision requirement
Up to one year	20 per cent
One to three years	30 per cent
More than three years (D-III) (i) outstanding  stock of NPAs as of March 31, 2010 (ii) advances classified as  ‘doubtful for more than three years’ on or after April 1, 2010	-  50 per cent. - 60 per cent with effect from March 31, 2011 - 75 per cent with effect from March 31, 2012 - 100 per cent with effect from March 31, 2013 -100 percent

Tier II Bank-

Period for which the advance has remained in the ‘doubtful’ category	Provision requirement
Up to one year	20 per cent
One to three years	30 per cent
More than three years (D-III) (i) outstanding  stock of NPAs as of March 31, 2007 (ii) advances classified as  ‘doubtful for more than three years’ on or after April 1, 2007	-  60 per cent with effect from March 31, 2008  -75 per cent with effect from March 31, 2009 - 100 per cent with effect from March 31, 2010 - 100 percent

 (iii) Sub-standard Assets

A general provision of 10 per cent on the total outstanding should be made without making any allowance for DICGC/ECGC guarantee cover and securities available.

(iv)  Provision on Standard Assets

(a) From the year ended March 31, 2000, the banks should make a general provision of a minimum of 0.25 per cent on standard assets.

(b) However, Tier II banks -The general provisioning requirement for all types of ‘standard advances’ shall be 0.40 per cent.  However, direct advances to agricultural and SME sectors which are standard assets, would attract a uniform provisioning requirement of 0.25 per cent of the funded outstanding on a portfolio basis,

(c) The provisions towards “standard assets” need not be netted from gross advances but shown separately as "Contingent Provision against Standard Assets" under "Other Funds and Reserves" {item.2 (viii) of Capital and Liabilities} in the Balance Sheet.

Dr Sucheta Dalvi 

 

Non-Performing Assets

 Reserve Bank of India defines Non-Performing Assets in India as any advances or loan that is overdue for more than 90 days.

Types of Non- Performing Assets (NPA)

a) Sub- Standard Assets

An asset is classified as a sub-standard asset if it remains as an NPA for a period less than or equal to 12 months.

b) Doubtful Assets

An asset is classified as a doubtful asset if it remains in sub-standard category for more than 12 months.

c) Loss Assets

An asset is considered as a loss asset when it is 'uncollectible' and of such little value that it's continuence as a bankable asset is not warranted.

Although there may be some salvage or recovery value  

GNPA

GNPA stands for gross non- performing assets. it is a total value of non- performing assets.

NNPA

NNPA stands for Net Non-Performing Assets. NNPA substracts the provisions made by the bank from the gross NPA. Therefore Net NPA gives you the exact value of non- performing assets after the bank has made specific provisions 

NPA Ratio

GNPA Ratio= GNPA/total advances

NNPA Ratio= NNPA/ total advances

To check the soundness of bank's financial condition,one should check the NPA Ratio

Dr Sucheta Dalvi

Activity Based Costing

Meaning 

 Activity-based costing (ABC) is a new and scientific approach developed by Cooper and Kaplan (1988) for assigning overhead to end products, jobs, and processes. It aims to rectify the problems of inaccurate cost information due to the selection of wrong bases of indirect cost apportionment. In the words of Kooper and Kaplan "ABC system calculate the cost of individual activities and assigned cost to cost object such asproduct and services on the basis of activites undertaken to produce eachprodct or service" 

According to CIMA, London, Activity Based Costing is " Cost attribution to cost units on the basis of benefits received from indirect activities ie ordering, setting, assuring quality, etc.

Activity-based costing is not an alternative to Job Costing or Process Costing. Rather it is a modern tool of charging overhead costs in which costs are first traced to activities and then to product or job thus activities become the focal point for cost computation. 

Step in Activity Based Costing 

The following are the steps in activity-based cost allocation 

1. Identification of the main activities- 

first of all, all major activities in the organization are identified. The number of activities in an organization should neither be too large or too small.

2. Creation of cost pool 

A cost pool is the grouping of individual cost items. A cost pool or cost bucket should be created for each activity. a cost pool is like a cost center around which costs are accumulated e.g the total cost of machine setups might constitute one cost pool for all set up related costs. 

3. Determination of the activity cost driver 

The factor that influences the cost of a particular activity is known as the activity cost driver. In other words, cost drivers signify the factors or events that determine the cost of an activity. eg cost drivers as given above are number of machine setups, number of purchases orders.  

4. Calculation of the activity cost driver rate  

Just as an overhead absorption rate calculated in a traditional costing system in ABC, the activity cost driver rate is calculated as follows-

Activity cost driver =  total cost of an activity 

                                    ___________________

                                     Cost Driver 

5. Charging cost of activities to product 

the cost of activities is traced to the product on the basis of demand by product. The cost driver is used to measure the product demand of activities. e.g the total cost allocated to the cost center for machine setup related costs are Rs 50,000/- and that there were 100 setups during the period thus the rate per set up is Rs 50000/100= 500 

if a particular product needs 10 setups,  charge to that product will be Rs 5000. if 20 units of the product are produced,  cost per unit will be Rs 5000/20 = 250. In this way cost of other activities  also will be charged to product. 

Advantages of Activity Based Costing   

ABC is  being implemented by a growing number of companies around the world 

1. Accurate and reliable - ABC  is a more accurate and reliable system of determination of product cost as it is based on cause and effect relationships. 

2. Better pricing decision - It helps in overcoming the problem of overcasting and under costing. 

3. Realistic- This method is more realistic because the distribution of overhead based on activity-based costing is an objective approach It may be recalled that traditional costing uses a more arbitrary base for apportionment of overhead and is a subjective approach. 

4. Control of cost -  ABC produces more meaningful information regarding cost behavior and helps management to control many fixed overheads by exercising more control over those activities which caused this fixed overhead.

5. Greater cost-efficiency-  and helps to identify unnecessary activities so that these may be weeded out and thus achieving greater cost efficiency.  

Dr. Sucheta Dalvi 

T J College, Khadki,Pune