It is not easy to find value stocks. Being aware of a company's key financial numbers like earnings per share and sales growth can help investors identify stocks that are trading for less than their worth. However, a proper analysis of the fundamentals with the help of a number of metrics is required to determine whether a stock is a good bargain or not.
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 low-priced stocks with high-growth prospects.
The P/B ratio is calculated as below:
P/B ratio = market price per share/book value of equity per share.
The P/B ratio helps to identify low-priced stocks that have high growth prospects. Select Medical Holdings Corporation SEM, Office Properties Income Trust OPI, KB Financial Group KB, PagSeguro Digital Ltd. PAGS and EnerSys ENS are some such stocks.
Now let us understand the concept of book value.
Understanding Book Value?
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 the common stockholders’ equity on the balance sheet. However, depending on the company’s balance sheet, intangible assets should also be subtracted from the 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 of 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 of 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 the P/E ratio to the future growth rate of the company. The 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 our five picks out of the six stocks that qualified the screening:
Mechanicsburg, PA-based Select Medical is a healthcare company, which owns long-term acute care and inpatient rehabilitation hospitals, as well as occupational health and physical therapy clinics. Select Medical has a Zacks Rank #2 and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
SEM has a projected 3-5-year EPS growth rate of 23.41%.
Office Properties Income Trust is a real estate investment trust. It owns buildings primarily leased to single tenants as well as government entities. Office Properties Income Trust, formerly known as Government Properties Income Trust, is based in Newton, United States.
Office Properties Income Trust has a Zacks Rank #2 and a Value Score of A. The company has a projected 3-5-year EPS growth rate of 11.34%.
KB Financial Group is a commercial bank in Korea. The company provides credit and related financial services mainly to individuals and small and medium-sized enterprises. It also provides a range of deposit products and related services to individuals and enterprises of all sizes.
KB Financial Group has a projected 3–5-year EPS growth rate of 12.46%. KB currently has a Zacks Rank #2 and a Value Score of A.
Headquartered in Sao Paulo, Brazil, PagSeguro Digital provides financial technology solutions and services to micro-merchants and small and medium-sized businesses primarily in Brazil and also internationally.
PAGS has a Zacks Rank #2 and a Value Score of A. PAGS has a projected 3–5-year EPS growth rate of 9.89%.
Headquartered in Pennsylvania, EnerSys engages in manufacturing, marketing and distribution of various industrial batteries. Additionally, the company develops battery chargers and accessories, power equipment and outdoor cabinet enclosures. This apart, it provides support services for clients.
EnerSys has a projected 3-5-year EPS growth rate of 14%. ENS currently has a Zacks Rank #2 and a Value Score of A.
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