Value analysis is the best approach to identify great bargains. Though price-to-earnings (P/E) and price-to-sales (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.
The P/B ratio, sometimes called the market-to-book ratio, is used to calculate how much an investor needs to pay for each dollar of book value of a stock. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.
P/B ratio = market capitalization/book value of equity
The P/B ratio helps to identify low-priced stocks that have high growth prospects.
Ford Motor Company ( F Quick Quote F - Free Report) , Phillips 66 ( PSX Quick Quote PSX - Free Report) , Turtle Beach Corporation ( HEAR Quick Quote HEAR - Free Report) , ASE Technology Holding ( ASX Quick Quote ASX - 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 16 stocks that qualified the screening:
Turtle Beach is an audio technology company. It designs audio products for consumer, commercial and healthcare markets. The company markets premium headsets for use with personal computers, mobile devices and video game consoles under the Turtle Beach brand.
Turtle Beach has a Zacks Rank #2 and a Value Score of A. Turtle Beach has a projected 3–5 year EPS growth rate of 16.0%.
Ford Motor designs, manufactures, markets and services cars, trucks, sport utility vehicles, electrified vehicles, and Lincoln luxury vehicles. Apart from vehicles, the company provides financial services through Ford Motor Credit Company. Ford Motor has a projected 3–5-year EPS growth rate of 9.10%. F currently has a Zacks Rank #2 and a Value Score of A. Phillips 66’s operations incorporate refining, midstream, marketing and specialties, and chemicals. The company, in its current form, came into existence following the 2012 spin-off of ConocoPhillips' downstream business into a separate, independent and publicly-traded entity.
Phillips 66 has a projected 3-5-year EPS growth rate of 11.60%. PSX currently has a Zacks Rank #1 and a Value Score of A. You can see
the complete list of today’s Zacks #1 Rank stocks here ASE Technology is a provider of semiconductor manufacturing services in assembly and testing.
ASE Technology has a projected 3-5 year EPS growth rate of 23.05%. ASE Technology currently has a Zacks Rank #2 and a Value Score of A.
Signet Jewelers is a retailer of diamond jewelry, watches as well as other products. SIG operates in the United States, Canada, U.K., the Republic of Ireland and the Channel Islands.
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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