When assessing a company’s valuation, investors typically rely on metrics such as the price-to-earnings (P/E) ratio and the price-to-sales (P/S) ratio. The P/E ratio measures how much investors are willing to pay for each dollar of a company’s earnings, while the P/S ratio indicates the value the market assigns to each dollar of revenues generated by the business.

Although P/E and P/S multiples are among the most widely used valuation tools, the price-to-book (P/B) ratio is another useful metric, particularly for identifying potentially undervalued stocks and companies with attractive long-term growth prospects. The P/B ratio compares a company’s market value with its book value, providing insight into how the market values the firm's net assets.

The P/B ratio is calculated as:

P/B Ratio = Market Capitalization ÷ Book Value of Equity

or equivalently,

P/B Ratio = Share Price ÷ Book Value per Share.

This metric can help identify attractively priced stocks with upside potential. Some such stocks are StoneCo (STNE Quick QuoteSTNE - Free Report) , USANA Health Sciences (USNA Quick QuoteUSNA - Free Report) , Strategic Education (STRA Quick QuoteSTRA - Free Report) , Nexa Resources (NEXA Quick QuoteNEXA - Free Report) and CVS Health Corporation (CVS Quick QuoteCVS - 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.

Book Value Per Share = (Total Assets – Total Liabilities) ÷ Number of Outstanding Shares

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 14 stocks that qualified for the screening: 

StoneCo provides financial technology solutions. The company offers an end-to-end cloud-based technology platform to conduct electronic commerce across in-store, online and mobile channels. StoneCo is based in Sao Paulo, Brazil.

STNE has a Zacks Rank #2 and a Value Score of A. STNE has a projected 3-5-year EPS growth rate of 23.6%. You can see the complete list of today’s Zacks #1 Rank stocks here.

USANA Health Sciences develops and manufactures high-quality nutritional, personal care and weight management products. USANA Health Sciences currently has a Zacks Rank #2 and a Value Score of A. USNA has a projected 3-5-year EPS growth rate of 12.0%.

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.

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 #1. NEXA has a projected 3-5-year EPS growth rate of 15.7%. 

Headquartered in Woonsocket, RI, CVS Health Corporation (formerly known as CVS Caremark Corporation) is a health solutions company with integrated offerings across the entire spectrum of pharmacy care.

CVS Health has a Zacks Rank #2 and a Value Score of A. CVS has a projected 3-5-year EPS growth rate of 13.7%.