The price-to-book (P/B) ratio is widely favored by value investors for identifying low-priced stocks with exceptional returns. The ratio is used to compare a stock’s market value/price to its book value.
The P/B ratio is calculated as below:
P/B ratio = market price per share/book value of equity per share
P/B ratio reflects how many times book value investors are ready to pay for a share. So if the share price is $10 and book value of equity is $5, investors are ready to pay two times the book value. Ideally, a P/B value under 1.0 is considered good, indicating a potentially undervalued stock. However, value investors often consider stocks with a P/B value under 3.0.
Now let us understand the concept of book value.
What is Book Value?
There are several ways by 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 goes bankrupt immediately. In other words, this is what shareholders would theoretically receive if a company liquidates all its assets after paying off its liabilities.
It is calculated by subtracting total liabilities from the total assets of a company. In most cases, this equates to the 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.
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. 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.
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 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 with a Zacks Rank #1 or 2 offer the best opportunities in the value investing space.
Here are five stocks that qualified the screening:
Xcerra Corporation (XCRA - Free Report) engages in designing, manufacturing, and marketing automatic test equipment for the semiconductor industry. The company has a projected 3-5 year EPS growth rate of 16%. Xcerra has a Value Score of A and carries a Zacks Rank #2.
Daqo New Energy Corp. (DQ - Free Report) is engaged in the manufacture and sale of high-quality polysilicon to photovoltaic product manufacturers. The company has a projected 3–5 year EPS growth rate of 7%. Daqo New Energy has a Zacks Rank #1 and a Value Score of A.
American Axle & Manufacturing Holdings, Inc. (AXL - Free Report) is a leading supplier of driveline and drivetrain systems, modules and components for the light vehicle market. The company has a projected 3-5 year EPS growth rate of 8.1%. The stock has a Value Score of A and a Zacks Rank #1.
Blucora, Inc. (BCOR - Free Report) provides technology-enabled financial solutions to consumers, small businesses and tax professionals. The company has a projected 3-5 year EPS growth rate of 20%. Blucora has a Zacks Rank #2 and a Value Score of B.
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 14.9%. Lam Research has a Zacks Rank #2 and a Value Score of A.
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