Value investors prefer price-to-earnings (P/E) and price-to-sales (P/S) ratios to identify low-priced stocks with exceptional returns. However, the understated price-to-book ratio (P/B ratio) is also an easy-to-use valuation tool for this purpose. The ratio is used to compare the market value/price of a stock to its book value.
The P/B ratio is calculated as follows:
P/B ratio = market price per share / book value of equity per share
The P/B ratio reflects the number of times investors’ book value is willing to pay for a stock. So, if the stock price is $10 and the equity book value is $5, investors are willing to pay double the book value. Ideally, a P/B value below 1.0 is considered good, indicating a potentially undervalued stock. However, value investors often consider stocks with a P/B value below 3.0.
The P/B ratio helps identify low-priced stocks that have high growth prospects. celestial (CLS – free report), ESA Technology (ASX – free report), Harley-Davidson (PORK – free report), Teak Resources Limited (TEAK – free report) and Hillenbrand (HI – Free Report) are some of those choices.
Now let’s understand the concept of book value.
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 18 stocks that qualified the selection:
celestial is one of the world’s largest electronics manufacturing services companies, serving the computer and communications industries.
Celestica has a Zacks Rank #1 and a Value Score of A. Celestica has an expected 3-5 year EPS growth rate of 14.5%.
You can see the full list of today’s Zacks #1 Rank stocks here.
ASE Technology Holding is a provider of semiconductor manufacturing services in the areas of assembly and testing.
ASE Technology Holding forecasts an EPS growth rate of 26.9% over 3 to 5 years. ASE Technology Holding currently has a Zacks Rank #2 and a Value Score of A.
Teak Resources Limited is a diversified resource company engaged in mining and mining development with business units focused on steel, coal, copper, zinc and energy.
Teck Resources forecasts an EPS growth rate of 38.7% over 3 to 5 years. TECK currently has a Zacks rank #2 and a value score of A.
Harley-Davidson is one of the world’s leading motorcycle manufacturers. It is the parent entity of groups of companies doing business as Harley-Davidson Motor Company and Harley-Davidson Financial Services.
Harley-Davidson has forecast an EPS growth rate of 46.4% over 3 to 5 years. TECK currently has a Zacks rank #1 and a value score of A.
Hillenbrand is a diversified global industrial company with multiple market-leading brands that serve a wide variety of industries around the world. Hillenbrand’s portfolio includes two business segments: the Process Equipment Group and Batesville.
Hillenbrand forecasts an EPS growth rate of 12% over 3 to 5 years. Hillenbrand currently has a Zacks rank #2 and a value score of A.
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