Value investing offers an opportunity to enter the market and grab stocks that have otherwise been overlooked by the majority of investors and are thus trading at cheap multiples.
Though price to earnings (P/E) and price to sales (P/S) valuation tools are more commonly used for stock selection, the price-to-book ratio (P/B ratio) is also an easy-to-use metric for identifying bargain stocks with high-growth prospects. The P/B ratio compares the market and book value of the company.
The P/B ratio is calculated as below:
P/B ratio = market capitalization/book value of equity
What is Book Value?
There are several ways by which book value can be defined. Book value is the total value that would be left over, according to the company’s balance sheet, if it goes bankrupt immediately. In other words, this is what shareholders would theoretically receive if a company liquidates all its assets after paying off all its liabilities.
It is calculated by subtracting total liabilities from the total assets of a company. In most cases, this equates to common stockholders’ equity on the balance sheet. However, depending on the company’s balance sheet, intangible assets should also be subtracted from total assets to determine book value.
Understanding P/B Ratio
By comparing the book value of equity to its market price, we get an idea of whether a company is under- or overpriced. However, like P/E or P/S ratio, it is always better to compare P/B ratios within industries.
A P/B ratio less than one means that the stock is trading at less than its book value, or the stock is undervalued and therefore a good buy. Conversely, a stock with a ratio greater than one can be interpreted as being overvalued or relatively expensive.
For example, a stock with a P/B ratio of 2 means that we pay $2 for every $1 of book value. Thus, the higher the P/B, the more expensive the stock.
But there is a caveat. A P/B ratio less than one can also mean that the company is earning weak or even negative returns on its assets, or that the assets are overstated, in which case the stock should be shunned because it may be destroying shareholder value. Conversely, the stock’s price may be significantly high — thereby pushing the P/B ratio to more than one — in the likely case that it has become a takeover target, a good enough reason to own the stock.
Moreover, the P/B ratio isn't without limitations. It is useful for businesses — like finance, investments, insurance and banking or manufacturing companies — with many liquid/tangible assets on the books. However, it can be misleading for firms with significant R&D expenditure, high debt, service companies or those with negative earnings.
In any case, the ratio is not particularly relevant as a standalone number. One should analyze other ratios like P/E, P/S and debt to equity before arriving at a reasonable investment decision.
Price to Book (common Equity) less than X-Industry Median: A lower P/B compared with the industry average implies that there is enough room for the stock to gain.
Price to Sales less than X-Industry Median: The P/S ratio determines how much the market values every dollar of the company’s sales/revenues — a lower ratio than the industry makes the stock attractive.
Price to Earnings using F(1) estimate less than X-Industry Median: The P/E ratio (F1) values a company based on its current share price relative to its estimated earnings per share — a lower ratio than the industry is considered better.
PEG less than 1: PEG links P/E ratio to the future growth rate of the company. PEG ratio portrays a more complete picture than the P/E ratio. A value of less than 1 indicates that the stock is undervalued and investors need to pay less for a stock that has bright earnings growth prospects.
Current Price greater than or equal to $5: They must all be trading at a minimum of $5 or higher.
Average 20-Day Volume greater than or equal to 100,000: A substantial trading volume ensures that the stock is easily tradable.
Zacks Rank less than or equal to #2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.
Value Score equal to A or B: Our research shows that stocks with a Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best opportunities in the value investing space.
Here are four stocks that qualified the screening:
Celestica CLS, an electronics manufacturing services company, has a projected 3-5 year EPS growth rate of 13.5%. It currently has a Zacks Rank #2 and a Value Score of A.
Affiliated Managers Group AMG, a global asset management company, has a Zacks Rank of 2. It has a 3-5 year EPS growth rate of 11.9% and a Value Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.
Canadian Solar CSIQ, a manufacturer of solar products and solar system solutions, has a projected 3-5 year EPS growth rate of 32%. It currently has a Zacks Rank #2 and a Value Score of A.
Vistra Energy VST, an energy company, is currently a Zacks #1 Ranked stock. It has a 3-5 year EPS growth rate of 11.9% and a Value Score of A.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Canadian Solar Inc. (CSIQ) : Free Stock Analysis Report
Affiliated Managers Group, Inc. (AMG) : Free Stock Analysis Report
Celestica, Inc. (CLS) : Free Stock Analysis Report
Vistra Energy Corp. (VST) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research