When considering the determinants of the price to book value ratio (P/BV) which of the following statements are correct?
I. The greater a company's return on common stockholders' equity the greater the P/BV ratio, all other things being equal
II. The greater a company's cost of equity the greater the P/BV ratio, all other things being equal
III. The greater a company's return on common stockholders' equity equals a company's cost of equity the P/BV ratio should equal 1.0
IV. The greater a company's current earnings the higher the P/BV ratio

Question

Quizplus · Accepted Answer

I is correct, as a higher return on common stockholders' equity would indicate a more profitable company and therefore, a higher P/BV ratio.

II is incorrect, as a higher cost of equity would imply a lower valuation and ultimately, a lower P/BV ratio.

III is correct, as if a company's return on common stockholders' equity equals a company's cost of equity, then the P/BV ratio should be 1.0, indicating that the market is valuing the company based on its book value.

IV is incorrect, as the price is not directly correlated to the current earnings in the P/BV ratio calculation.

When Considering the Determinants of the Price to Book Value