Of the valuation measures, the price-to-earnings (P/E) ratio and the price-to-sales (P/S) ratio are most commonly used for stock picking. Indeed, calculations based on revenue and, to some extent, sales are easy and convenient. However, the price-to-book ratio (P/B ratio) has become a handy tool for identifying low-priced stocks with high growth prospects.
The P/B ratio is used to calculate how much an investor should pay for each dollar of a stock’s book value. It is calculated by dividing the current closing share price by the last quarter’s book value per share.
P/B ratio = market capitalization / book value of equity
The P/B ratio helps identify low-priced stocks that have high growth prospects. Ford Motor Company F, General Motors Society GM, Knowledge base home KBH, Group 1 Automotive GPI, and Signet Jewelers Limited GIS are some of those choices.
What is the book value?
There are several ways to define book value. Book value is the total value that would remain, according to the company’s balance sheet, if it went bankrupt immediately. In other words, it’s what shareholders would theoretically receive if a company liquidated all of its assets after settling all of its liabilities.
It is calculated by subtracting the total liabilities from the total assets of a business. In most cases, this equates to common shareholders’ equity on the balance sheet. However, according to the company’s balance sheet, intangible assets must also be subtracted from total assets to determine book value.
Understanding the P/B ratio
By comparing the book value of equity to its market price, we get an idea if a company is undervalued or overvalued. However, like the P/E or P/S ratio, it is always best to compare P/B ratios within industries.
An AP/B ratio of less than one means the stock is trading at a price below 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 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. An AP/B ratio of less than one can also mean that the company is getting low or even negative returns on its assets or that the assets are overvalued, in which case the stock should be avoided as it can destroy shareholder value. Conversely, the price of the stock may be significantly high – thereby pushing the P/B ratio to more than one – in the likely event that it has become a buyout target, reason enough to hold the stock. .
Moreover, the P/B ratio is not without limits. It is useful for businesses – such as finance, investments, insurance, and banking or manufacturing companies – with many liquid/tangible assets on the books. However, this can be misleading for companies with large R&D expenses, high debt, service companies, or those with negative earnings.
In any case, the ratio is not particularly relevant as a stand-alone number. Other ratios such as P/E, P/S and debt/equity should be analyzed before making a reasonable investment decision.
Price to Book (common Equity) below the X-Industry median: A lower P/B relative to the industry average implies that there is enough room for the stock to win.
Selling price below median X-Industry: The P/S ratio determines how much the market values each dollar of the company’s sales/revenue – a lower ratio than the industry makes the stock attractive.
Price/earnings ratio using F(1) estimate below industry median X: The P/E (F1) ratio 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: The PEG relates the P/E ratio to the future growth rate of the company. The PEG ratio gives a more complete picture than the P/E ratio. A value below 1 indicates the stock is undervalued and investors should pay less for a stock that offers good earnings growth prospects.
Current price greater than or equal to $5: They must all trade at a minimum of $5 or more.
Average volume over 20 days greater than or equal to 100,000: Substantial trading volume ensures that the stock is easily tradable.
Zacks rating less than or equal to #2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform regardless of the market environment.
Value Score of A or B: Our research shows that stocks with a Value Score of A or B, when combined with a Zacks #1 or 2 ranking, offer the best opportunities in the investment space valuable.
Here are our five picks from the 15 stocks that qualified the selection:
Ford Motor Company designs, manufactures, markets and services Lincoln cars, trucks, sport utility vehicles, electrified vehicles and luxury vehicles.
Ford Motor forecasts an EPS growth rate of 25.2% over 3 to 5 years. Ford Motor currently has a Zacks Rank #1 and a Value Score of A. You can see the full list of today’s Zacks Rank #1 stocks here.
Group 1 Automotive is a leader in automobile distribution. Through these dealerships, the company sells new and used cars and light trucks. In addition to the sale of new and used vehicles, Group 1 Automotive offers vehicle financing, insurance and service contracts.
Group 1 Automotive has an expected EPS growth rate of 12.1% over 3 to 5 years. He currently has a Zacks rank of No. 2 and a value score of A.
General Motors Company is one of the largest automobile manufacturers in the world. The top US automaker aims to spend more than $27 billion through 2025 to launch next-generation electric vehicles powered by new low-cost batteries. General Motors plans to roll out 11 new electric vehicles as part of its ambitious plans through 2025, including at least 20 new models by 2023.
General Motors has a Zacks rank of No. 2 and a value score of A. General Motors has an expected EPS growth rate of 9.9% over 3-5 years.
Knowledge base home is a well-known home builder in the United States and one of the largest in the state. KB Home has a Zacks rank of #1 and a value score of B.
KBH’s homebuilding business includes the construction and design of homes that appeal to first-time homebuyers, upwards and working adults on acquired or developed land. KB Home also builds single family homes, townhouses and condominiums. KB Home forecasts an EPS growth rate of 17.2% over 3 to 5 years.
Bookmark Jewelers is a retailer of diamond jewelry, watches and other products.
Signet Jewelers forecasts an EPS growth rate of 8% over 3-5 years. Signet Jewelers currently has a Zacks rank #1 and a value score of A.
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Ford Motor Company (F): Free Inventory Analysis Report
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