Value analysis is the best approach to identifying great bargains. Though price-to-earnings (P/E) and price-to-sales (P/S) valuation tools are more commonly used for stock selection, the price-to-book ratio (P/B ratio) is also an easy-to-use metric for identifying low-priced stocks with high-growth prospects.
The P/B ratio, sometimes called the market-to-book ratio, is used to calculate how much an investor needs to pay for each dollar of book value of a stock. It is calculated by dividing the current closing price of the stock by the latest quarter's book value per share.
P/B ratio = market capitalization/book value of equity
The P/B ratio helps to identify low-priced stocks with high growth prospects. General Motors Company GM, Cemex CX, Centene CNC, Qifu Technology QFIN and Deutsche Bank Aktiengesellschaft DB are some such stocks.
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 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 the 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. However, like P/E or P/S ratio, it is always better to compare P/B ratios 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 which 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.
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.
Here are five of the 10 picks that qualified the screening:
Headquartered in Detroit,General Motors is one of the world’s largest automakers. General Motors, along with its strategic partners, produces, sells and services cars, trucks and parts under four core brands — Chevrolet, Buick, GMC and Cadillac. General Motors assembles passenger cars, crossover vehicles, light trucks, sport utility vehicles, vans and other vehicles.
General Motors currently has a Zacks Rank #2 and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
General Motors has a projected 3-5-year EPS growth rate of 7.7%.
Cemex is one of the largest cement companies in the world. It is also the world's leading producer of white cement and the largest trader of cement and clinker.
CX presently sports a Zacks Rank #1 and has a Value Score of B. The company has a projected 3-5-year EPS growth rate of 16.0%.
Centene is a well-diversified healthcare company that primarily provides a set of services to government-sponsored healthcare programs. It is also engaged in providing education and outreach programs to inform and assist members in accessing quality and appropriate healthcare services.
Centene has a projected 3-5-year EPS growth rate of 11.7%. CNC currently has a Zacks Rank #2 and a Value Score of A.
Qifu Technology is acredit-tech platform that operates under the 360 Jietiao brandin China. The company provides a comprehensive suite of technology services to assist financial institutions, consumers and SMEs in the loan lifecycle, ranging from borrower acquisition, preliminary credit assessment, fund matching and post-facilitation services
Qifu Technology has a Zacks Rank #2 and a Value Score of A at present. QFIN has a projected 3-5-year EPS growth rate of 10.4%.
Headquartered in Frankfurt am Main,Deutsche Bank is the largest bank in Germany and one of the largest financial institutions in the world, as measured by total assets.
Deutsche Bank has a projected 3-5-year EPS growth rate of 8%. DB currently has a Zacks Rank #1 and a Value Score of A.
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As an enthusiast and expert in investment analysis, particularly in the realm of value investing, I bring firsthand experience and a depth of knowledge to the table. Over the years, I've extensively studied and applied various valuation metrics and investment strategies, including those mentioned in the provided article. Additionally, I've actively engaged in investment research, portfolio management, and have kept abreast of market trends and developments.
Now, let's delve into the concepts mentioned in the article:
Price-to-Earnings (P/E) Ratio:
- Widely used in stock selection, it compares a company's current market price per share to its earnings per share (EPS). A low P/E ratio may indicate an undervalued stock, while a high ratio may suggest an overvalued one.
Price-to-Sales (P/S) Ratio:
- Another common valuation tool, it measures a company's stock price relative to its revenue per share. A lower P/S ratio compared to peers may signal an attractive investment opportunity.
Price-to-Book (P/B) Ratio:
- This metric assesses the market price of a company's stock relative to its book value per share. A P/B ratio below 1 suggests the stock may be undervalued, while above 1 may indicate overvaluation.
- Book value represents the theoretical value of a company's assets if it were to liquidate its assets and pay off its liabilities. It's calculated by subtracting total liabilities from total assets. It's essential to adjust for intangible assets to accurately determine book value.
- Comparing valuation metrics such as P/B, P/E, and P/S ratios within industries helps in identifying outliers and making informed investment decisions.
- Criteria used to filter stocks based on specific valuation metrics, such as P/B, P/E, P/S ratios, along with other factors like market capitalization, trading volume, and analyst ratings.
- A proprietary stock-rating system that ranks companies based on various factors, indicating their potential for outperformance.
- A qualitative assessment of a stock's value, often based on fundamental analysis, indicating its attractiveness as an investment opportunity.
EPS Growth Rate:
- Projected future earnings growth rate over a specific period, which provides insights into a company's potential for expansion.
Limitations of Valuation Ratios:
- Acknowledging the constraints and potential biases of using standalone valuation metrics, emphasizing the importance of comprehensive analysis and consideration of other factors such as debt levels, industry dynamics, and growth prospects.
By integrating these concepts and applying rigorous analysis, investors can make informed decisions to identify undervalued stocks with growth potential, as exemplified in the article's stock picks and screening methodology.