When evaluating a company’s value, investors mostly look at the stock’s price-to-earnings (P/E) or price-to-sales (P/S) ratio. While P/E is the ratio of annual earnings to stock price, P/S reflects the amount investors pay for each dollar of revenues generated by the company.
Though P/E and 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.
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
The P/B ratio helps identify low-priced stocks with high growth prospects. JD.com JD, City Office REIT CIO, Fresenius Medical Care FMS, Itron ITRI and Enersys ENS are some such stocks.
Now, let us understand the concept of book value.
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 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 warning. 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 such a 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 is not 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.
Screening Parameters
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.
5 Low Price-to-Book Stocks
Here are five of the 12 stocks that qualified the screening:
JD.com operates as an online direct sales company in China. The company, through its website www.jd.com and mobile applications, offers a selection of authentic products, including computers, mobile handsets, home appliances, automobile accessories, clothing and shoes, luxury goods, furniture and household products, personal care items, food and nutritional supplements and much more.
JD presently has a Zacks Rank #1 and a Value Score of A. The company has a projected 3-5-year EPS growth rate of 32.3%.
Vancouver, Canada-based City Office REIT is a real estate investment trust. It focuses on acquiring, owning and operating office properties in the United States. The company invests in properties located in metropolitan areas in the Southern and Western United States.
City Office REIT has a Zacks Rank #2 and a Value Score of A at present. CIO has a projected 3-5-year EPS growth rate of 6.0%.
Based in Bad Homburg, Germany, Fresenius Medical Care is one of the largest integrated providers of products and services for individuals undergoing dialysis following chronic kidney failure. Fresenius Medical currently has a Zacks Rank #1 and a Value Score of A.
FMS has a projected 3-5-year EPS growth rate of 11.9%.
Headquartered in Liberty Lake, WA, Itron is a technology and services company and one of the leading global suppliers of a wide range of standard, advanced, and smart meters and meter communication systems, including networks and communication modules, software, devices, sensors, data analytics and services to the utility and municipal sectors.
Itron has a Zacks Rank #2 and a Value Score of B. ITRI has a projected 3-5-year EPS growth rate of 29.0%.
Headquartered in Pennsylvania, EnerSys manufactures, markets and distributes various industrial batteries worldwide. It currently has a Zacks Rank of #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
ENS has a Value Score of A and a projected 3-5-year EPS growth rate of 18.0%.
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Itron, Inc. (ITRI) : Free Stock Analysis Report
Fresenius Medical Care AG & Co. KGaA (FMS) : Free Stock Analysis Report
Enersys (ENS) : Free Stock Analysis Report
JD.com, Inc. (JD) : Free Stock Analysis Report
City Office REIT, Inc. (CIO) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
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