When evaluating a company, investors mostly look at a 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 to identify low-priced stocks that have high growth prospects.
Itron ( ITRI Quick Quote ITRI - Free Report) , PVH Corp. ( PVH Quick Quote PVH - Free Report) , Centene ( CNC Quick Quote CNC - Free Report) and Park Hotels & Resorts ( PK Quick Quote PK - Free Report) 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 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 the four picks that qualified the screening:
Headquartered in Liberty Lake, WA,
Itron is a technology 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. Itron 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.
Itron has a projected 3-5-year EPS growth rate of 23.0%.
PVH Corp. specializes in designing and marketing branded dress shirts, neckwear, sportswear, jeanswear, intimate apparel, swim products, footwear, handbags and related products.
PVH has a Zacks Rank #2 and a Value Score of A. PVH has a projected 3–5-year EPS growth rate of 13.30%.
Centene is a well-diversified healthcare company that primarily provides a set of services to government-sponsored healthcare programs. It is also engaged in providing education and outreach programs to inform and assist members in accessing quality, appropriate healthcare services.
Centene has a projected 3–5-year EPS growth rate of 12.83%. CNC currently has a Zacks Rank #2 and a Value Score of A.
Headquartered in Virginia,
Park Hotels & Resorts is a lodging real estate company. It operates luxury hotels and resorts in the USA and international markets.
PK has a Zacks Rank #2 and a Value Score of A. Park Hotels & Resorts has a projected 3–5-year EPS growth rate of 7.95%.
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