A stock’s price-to-book ratio or P/B ratio is essentially the ratio of its price to book value or in other words how much an investor needs to pay for each dollar of book value of a stock.
In value investing, it is a common practice to pick stocks that are cheap but fundamentally strong. There are a number of investment styles for finding great stocks at attractive values.
Though price-to-earnings and price-to-sales are preferred by investors while choosing value stocks, the P/B ratio has also emerged as a convenient tool for identifying low-priced stocks that have high-growth prospects.
It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.
Take a look at the formula of P/B ratio:
P/B ratio = market capitalization/book value of equity.
Understanding Book Value?
There are several ways by which book value can be defined. It 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 would equate 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 the book value.
Explaining the 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 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.
But there is a caveat. A P/B ratio 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 share 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 expenditures, high-debt companies, service companies or those with negative earnings.
In any case, the ratio is not particularly relevant as a standalone number. One should also analyze other ratios like P/E, P/S, and debt to equity before arriving at a reasonable investment decision.
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 ratio links the P/E ratio to the future growth rate of the company. 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 a bright earnings growth prospect.
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 Style Score equal to A or B: Our research shows that stocks with a Value Style Score of ‘A’ or ‘B’ when combined a Zacks Rank #1 or 2 offer the best opportunities in the value investing space.
Here are five of the six stocks that qualified the screening:
Magellan Health, Inc. (MGLN - Free Report) , a managed care organization, has a projected 3–5 year EPS growth rate of 13.0%. Currently, the stock has a Value Score of ‘A’ and a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Lannett Company, Inc. (LCI - Free Report) , a generic pharma company, has a projected 3–5 year EPS growth rate of 12.5%. Currently, the stock has a Value Score of ‘A’ and a Zacks Rank #2.
OneMain Holdings, Inc. (OMF - Free Report) , a consumer financial services holding company, currently has a Zacks Rank #2 and a Value Score of ‘A’. The company’s projected 3–5 year EPS growth rate is 10%.
Volkswagen Aktiengesellschaft (VLKAY - Free Report) , a European automobile manufacturer, has a Zacks Rank #1. It has a 3–5 year EPS growth rate of 17.27% and a Value Score of ‘A’.
Lam Research Corporation (LRCX - Free Report) is a leading global provider of innovative wafer fabrication equipment and services to the semiconductor industry. The company has a projected 3–5 year EPS growth rate of 17.2%. Currently, Citizens Financial has a Zacks Rank #1 and a Value Score of ‘B’.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
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