Question

Why will a firm that has a significant amount of omitted assets have have a high price to book ratio compared to a firm with few omitted assets

Answer 1

Answer : -

The price-to-book ratio = Stock price ÷ [ total assets - total liabilities]

The more the omitted assets the lower will be the total assets which will result in high price-to-book ratio as the amount of total assets - total liabilities will be less as compared to companies whose omitted assets are less resulting in high total assets and the amount of total assets - total liabilities will be more resulting in low compared to case 1 price-to-book ratio.

Example, if company has $200,000 total assets and $100,000 total liabilities and stock price is $1,000,000 the price-to-book ratio will be = $1,000,000 ÷ [ $200,000 - $100,000] = $1,000,000 ÷ $100,000 = 10

If the company has less omitted assets, total assets is $250,000 and total liabilities is $100,000 and stock price is $1,000,000 the price-to-book ratio = $1,000,000 ÷ [$250,000 - $100,000] = $1,000,000 ÷ $150,000 = 6.66 price-to-book ratio.