Price-to-earnings (P/E) and price-to-sales (P/S) are among the most commonly used valuation metrics for investors looking to narrow down a list of potentially undervalued stocks. However, the price-to-book (P/B) ratio, while often overlooked, can also be a useful and straightforward tool for identifying stocks that may be trading below the value of their underlying assets.

The P/B ratio compares a company’s market value with the book value of its equity. A lower P/B ratio may indicate that a stock is relatively inexpensive compared with its net assets. However, investors should consider the ratio alongside factors such as return on equity (ROE), earnings growth, debt levels and industry averages, as an extremely low P/B ratio can also signal underlying business or financial challenges.

The P/B ratio is calculated as follows:

P/B ratio = Market capitalization ÷ Book value of equity

This metric can help identify attractively priced stocks with upside potential. Some such stocks are Teleflex (TFX Quick QuoteTFX - Free Report) , Centene Corporation (CNC Quick QuoteCNC - Free Report) , Enersys (ENS Quick QuoteENS - Free Report) , Gibraltar Industries (ROCK Quick QuoteROCK - Free Report) and First American Financial Corporation (FAF Quick QuoteFAF - 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 liquidated 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 16 stocks that qualified for the screening: 

Headquartered in Wayne, PA, Teleflex is a global provider of medical technology products. The company primarily designs, develops, manufactures and supplies single-use medical devices used by hospitals and healthcare providers for common diagnostic and therapeutic procedures in critical care and surgical applications.

TFX has a Zacks Rank #2 and a Value Score of B. Teleflex has a projected 3-5-year EPS growth rate of 20.7%. You can see the complete list of today’s Zacks #1 Rank stocks here.

St. Louis, MO-based Centene Corporation is a well-diversified, multinational healthcare company that primarily provides a set of services to government-sponsored healthcare programs. The company serves underinsured and uninsured individuals through member-focused services. It is also engaged in providing education and outreach programs to inform and assist members in accessing quality, appropriate healthcare services. 

Centene currently has a Zacks Rank #1 and a Value Score of A. CNC has a projected 3-5-year EPS growth rate of 32.4%. 

Headquartered in Reading, PA, EnerSys manufactures, markets and distributes various industrial batteries worldwide. It currently has a Zacks Rank of 2. 

ENS has a Value Score of A and a projected 3-5-year EPS growth rate of 15.0%.

NY-based Gibraltar Industries manufactures and distributes products to the industrial and building markets. The products range from ventilation and expanded metal to mail storage solutions and rain dispersion products and solutions.

ROCK currently has a Value Score of B and a Zacks Rank #2. Gibraltar Industries has a projected 3-5-year EPS growth rate of 15.0%. 

Headquartered in Santa Ana, CA, First American Financial Corporation, through its subsidiaries, provides title insurance, settlement services and other financial services and risk solutions to homeowners and lenders. Its revenues are reported under the title insurance and services segment and the home warranty segment.

First American Financial has a Zacks Rank #2 and a Value Score of A. FAF has a projected 3-5-year EPS growth rate of 15.2%.