Value investors have preferred price-to-earnings ratio or P/E for time immemorial as a means to identify value stocks. However, in case of loss-making companies that have a negative price-to-earnings ratio, the price-to-sales or P/S ratio is considered in determining their true value.
However, the price-to-book ratio (P/B ratio), though used less often, is also an easy-to-use valuation tool for identifying low-priced stocks with great returns.
P/B is the ratio of stock price to book value
It is calculated as below:
P/B ratio = market capitalization/book value of equity
What is Book Value
There are several ways to determine book value. Book value is the total value that would be left, according to a company’s balance sheet, if it goes bankrupt. In other words, this is what shareholders would theoretically receive if a company liquidates all of its assets after paying off its liabilities.
It is calculated by subtracting total liabilities from total assets of a company. In most cases, this would equate to the common stockholders’ equity on the balance sheet. However, depending on the balance sheet, intangible assets should also be subtracted from total assets to determine the 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 ratio links the 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 seven of the 15 stocks that qualified the screening:
GMS Inc. GMS, a distributor of wallboard and suspended ceilings systems, currently has a Zacks Rank #2 and a Value Score of B. It has a 3-5 year EPS growth rate of 7%. You can see the complete list of today’s Zacks #1 Rank stocks here.
General Motors Company GM, a leading global automotive company, currently has a Zacks Rank #2. It has a 3-5 year EPS growth rate of 8.5% and a Value Score of A.
PCM, Inc. PCMI is a technology solutions provider to businesses, government and educational institutions and individual consumers. The Zacks Rank #2 company has a 3-5 year EPS growth rate of 20% and a Value Score of B.
Echo Global Logistics, Inc. ECHO is a leading provider of technology-enabled transportation and supply chain management services. The company currently has a Zacks Rank #2. It has a 3-5 year EPS growth rate of 17.5% and a Value Score of A.
Gulfport Energy Corporation GPOR is engaged in the acquisition, exploration, development and production of oil and natural gas properties in North America. The company has a Zacks Rank #2 and a Value Score of A. It has a 3-5 year EPS growth rate of 13.5%.
Barclays PLC BCS, a major global banking and financial services company, has a projected 3-5 year EPS growth rate of 19.5%. It currently has a Zacks Rank #2 and a Value Score of A.
CAI International, Inc. CAI, a leading intermodal freight container leasing and management company, has a projected 3-5 year EPS growth rate of 8%. Capital One currently has a Zacks Rank #2 and a Value Score of A.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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CAI International, Inc. (CAI) : Free Stock Analysis Report
Echo Global Logistics, Inc. (ECHO) : Free Stock Analysis Report
General Motors Company (GM) : Free Stock Analysis Report
Barclays PLC (BCS) : Free Stock Analysis Report
GMS Inc. (GMS) : Free Stock Analysis Report
PCM, Inc. (PCMI) : Free Stock Analysis Report
Gulfport Energy Corporation (GPOR) : Free Stock Analysis Report
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