Ask Colin

Do you place any value on the price to book ratio?

This ratio is one of Benjamin Graham’s criteria for his margin of safety. I discussed it in the appendix to my book The Aggressive Investor. Graham’s rule was to look for a price to book ratio of 1.5 or less. In other words, do not pay more than $1.50 for $1 of assets. Graham had an exception involving multiplying the price to book ratio by the PE ratio, which is also discussed in my book.

We should realise when we discuss this ratio that Graham was mainly looking at industrial companies. However, it is arguable that the economy has changed a lot since then and that this particular ratio is of less value in service companies where there are low levels of physical assets. However, the general idea remains sound that we should not pay too much for assets if we are a value investor. A growth or momentum investor would probably allow far more latitude on this ratio.

I do not place a lot of stress on this ratio. I think there are far more important elements in the total picture. It is only one small part of my view of a company. I certainly do not give it any special characteristics.

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