In valuation analysis, while ratios like the price-to-earnings (P/E) and price-to-sales (P/S) multiples are more commonly used by investors, the often-overlooked price-to-book (P/B) ratio can also be a practical tool for spotting potentially undervalued stocks with attractive return potential. The P/B ratio compares a company’s current market price with the book value of its equity.

The formula is:

P/B ratio = Market price per share ÷ Book value per share

Book value per share is calculated by dividing a company’s total shareholders’ equity by its number of outstanding shares.

The P/B ratio indicates how much investors are willing to pay for each dollar of a company’s net assets. For example, if a stock trades at $10 per share and its book value per share is $5, the P/B ratio is 2. This means investors are willing to pay two times the company’s book value for each share.

This metric can help identify attractively priced stocks with upside potential like Hudson Pacific Properties (HPP Quick QuoteHPP - Free Report) , Strategic Education (STRA Quick QuoteSTRA - Free Report) , Hilton Grand Vacations (HGV Quick QuoteHGV - Free Report) , Nexa Resources (NEXA Quick QuoteNEXA - Free Report) and Avnet (AVT Quick QuoteAVT - Free Report) .

Let us understand the concept of book value.

What is Book Value?

There are several ways in 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 went 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 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. Like P/E or P/S ratios, it is always better to compare the P/B ratio 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 10 stocks that qualified for the screening: 

LA-based Hudson Pacific Properties is a full-service, vertically integrated real estate company focused on owning, operating and acquiring office properties and media and entertainment properties in select growth markets primarily in Northern and Southern California.  Hudson Pacific currently has a Zacks Rank #1 and a Value Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.

HPP has a projected 3-5-year EPS growth rate of 9.7%.

Herndon, VA-based Strategic Education, through its subsidiaries Strayer University and New York Code and Design Academy (NYCDA), provides a range of post-secondary education and other academic programs in the United States. NYCDA is a New York City-based provider of web and application software development courses. Strategic Education has a projected 3-5-year EPS growth rate of 15%.

STRA currently has a Zacks Rank #2 and a Value Score of A.

Orlando, FL-based Hilton Grand Vacations Company is a division of Hilton Worldwide. It is engaged in the hospitality business.  It markets and operates vacation ownership resorts and also manages and serves club membership programs.

HGV has a Zacks Rank #1 and a Value Score of B. HGV has a projected 3-5-year EPS growth rate of 22.0%. 

Luxembourg City, Brazil-based Nexa Resources is an integrated zinc producer. It is engaged in developing and operating mining and smelting assets, primarily in Latin America. NEXA currently has a Value Score of A and a Zacks Rank #2. NEXA has a projected 3-5-year EPS growth rate of 27.5%. 

Based in Phoenix, AZ, Avnet is one of the world’s largest distributors of electronic components and computer products. The company’s customer base includes original equipment manufacturers, electronic manufacturing services providers, original design manufacturers, and value-added resellers.

Avnet has a Zacks Rank #1 and a Value Score of B. AVT has a projected 3-5-year EPS growth rate of 28.1%.