In value analysis, though price to earnings (P/E) and price to sales (P/S) are most preferred by investors, the underrated price-to-book ratio (P/B ratio) is also an easy-to-use valuation tool for identifying low-priced stocks with exceptional returns. The ratio is used to compare a stock’s market value/price to its book value.
The P/B ratio is calculated as below:
P/B ratio = market price per share/book value of equity per share
P/B ratio reflects how many times book value investors are ready to pay for a share. So if the share price is $10 and the book value of equity is $5, investors are ready to pay two times the book value. Now let us understand the concept of book value.
The P/B ratio helps to identify low-priced stocks that have high growth prospects.
Vishay Intertechnology ( VSH Quick Quote VSH - Free Report) , Group 1 Automotive ( GPI Quick Quote GPI - Free Report) , Celestica ( CLS Quick Quote CLS - Free Report) , Select Medical Holdings Corporation ( SEM Quick Quote SEM - Free Report) , and Signet Jewelers Limited ( SIG Quick Quote SIG - Free Report) are some such stocks.
Now let us understand the concept of book value.
What’s 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.
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.
Here are our five picks out of the 11 stocks that qualified the screening:
Celestica is one of the largest electronics manufacturing services companies in the world, serving the computer and communications sectors.
Celestica has a Zacks Rank #2 and a Value Score of A. Celestica has a projected 3–5 year EPS growth rate of 15.44%.
Vishay Intertechnology is a global manufacturer and supplier of semiconductors and passive components. Vishay Intertechnology is benefiting from strength across its resistor, diode, MOSFET, capacitor, inductor and opto product lines as well as expanding manufacturing capacities.
Vishay Intertechnology has a projected 3-5 year EPS growth rate of 22.71%. Vishay Intertechnology currently has a Zacks Rank #2 and a Value Score of A.
Group 1 Automotive is a leading automotive retailer. Through its dealerships, the firm sells new and used cars and light trucks. Apart from selling new and used vehicles, Group 1 Automotive offers vehicle financing and insurance and service contracts.
Group 1 Automotive has a projected 3-5-year EPS growth rate of 14.19%. GPI currentlyhas a Zacks Rank #1 and a Value Score of A.
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.Since Select Medical’s inception in 1997, a number of acquisitions have been completed, the most notable deals being the buyout of Physiotherapy, Concentra and U.S. Health Works.
SEM currently 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. It has a projected 3-5 year EPS growth rate of 15.0%. Signet Jewelers is a retailer of diamond jewelry, watches as well as other products.
Signet Jewelers has a projected 3-5-year EPS growth rate of 8%. Signet Jewelers currently has a Zacks Rank #1 and a Value Score of A.
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