We recently saw in this blog the ratio Price Book value. As I already explained, it had the disadvantage of not reflecting on many occasions the real equity value of a company. To solve this problem, the Adjusted Book Value Price ratio arises, which goes beyond the book value to focus on the search for greater precision in the valuation. In this article I will explain what the Adjusted Book Value Price ratio measures with an example, when to use it and its advantages and disadvantages.
What is the Adjusted Book Value Price ratio?
The Price Value Adjusted Book Value or “PVCA” ratio is a stock market ratio that measures the relationship between the price at which a company is listed and the real value of its equity, that is, the real value of its assets less its debts.
The formula for the Price-Adjusted Book Value ratio is as follows:
PVCA = Market Capitalization / Real Equity Value
The real equity value of the company being the market value of its assets (goods and rights) less the market value of its debts and obligations.
Example of the calculation of the ratio Price Adjusted Book Value
Suppose a company, whose capitalization bursátil is 250 million euros, it has the following balance (in million euros):
- Real estate assets 75
- Inventory 50
- Box 25
- Equity 100
- Debts 50
The Book Value Price (PVC) ratio of this company will be 2,5, which is the result of dividing 250 million of capitalization by 100 million of equity. With a PVC ratio of 2,5 the company does not appear to be cheap.
However, we also know that the book price of real estate assets does not reflect reality. These lands, which are part of its real estate assets, have just been re-urbanized, so its real value has become around 500 million euros. However, its inventory has deteriorated and its real value is only 25 million.
Therefore, the company's adjusted book value will be the actual value of its assets (550, when adding 500 + 25 + 25) minus its debts 50. That is, it will have an adjusted book value of 500.
Its PVCA ratio will be 0,5 (250/500), which would make it a very interesting investment although at first glance it did not seem so.
When to use this ratio?
The PVCA ratio will be used in companies whose book value does not faithfully reflect their real equity value. If the PVCA ratio of a listed company is substantially less than 1, we may be facing a very interesting investment opportunity.
Advantages of the ratio Price Adjusted Book Value
Its main advantage is that it is the ratio that best reflects the real equity value of a company, since it goes beyond the book value that can reflect a distorted value of the equity value of the company.
Disadvantages of the ratio Price Adjusted Book Value
As with the simple PVC ratio, in most cases the equity value of a company does not reflect its real potential, since in many cases the source of intrinsic value of companies does not come from their equity, but from their ability to generate profits for its shareholders.
The second drawback of this ratio is its calculation. Sometimes it can be very difficult to know the real value of a company's assets and liabilities. In particular, in large companies with highly diversified assets, this task is almost impossible for small investors.