Price-to-earnings (P/E) and price-to-sales (P/S) are the first ratios that come to an investor’s mind while narrowing down a list of undervalued stocks. However, the price-to-book ratio (P/B ratio), though underrated, is also an easy-to-use valuation tool for identifying low-priced stocks with high-growth prospects.

P/B ratio is calculated as below:

P/B ratio = market capitalization/book value of equity.

This metric can help identify attractively priced stocks with upside potential. Some such stocks are Banco Macro S.A. (BMA Quick QuoteBMA - Free Report) , Avnet (AVT Quick QuoteAVT - Free Report) , Enersys (ENS Quick QuoteENS - Free Report) , General Motors (GM Quick QuoteGM - Free Report) and Huntington Ingalls Industries (HII Quick QuoteHII - 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: 

Banco Macro S.A. is a leading bank in Argentina. With the most extensive private-sector branch network in the country, Banco Macro provides standard banking products and services to a nationwide customer base.

BMA has a Zacks Rank #1 and a Value Score of A. Banco Macro has a projected 3-5-year EPS growth rate of 26.6%. You can see the complete list of today’s Zacks #1 Rank stocks here.

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 31.3%.

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 B and a projected 3-5-year EPS growth rate of 15.0%.

General Motors is a leading U.S. automaker that designs, manufactures and sells vehicles and automotive services across global markets. The company is headquartered in Detroit. Its main brands include Chevrolet, GMC, Cadillac and Buick, with offerings spanning passenger cars, SUVs, pickup trucks and electric vehicles, along with automotive financing through GM Financial.

It currently has a Zacks Rank of 2. GM has a Value Score of A and a projected 3-5-year EPS growth rate of 13.3%.

Based in Newport News, VA, Huntington Ingalls Industries designs, builds and maintains nuclear-powered ships, including aircraft carriers and submarines, and non-nuclear ships, including surface combatants, expeditionary warfare/amphibious assault and coastal defense ships for the U.S. Navy and Coast Guard. It also provides after-market services for military ships globally.

Huntington Ingalls has a Zacks Rank #2 and a Value Score of B. HII has a projected 3-5-year EPS growth rate of 14.4%.