Looking For Bargain Stocks? Pick These 5 With Low P/B Ratio
Zacks Investment Research | Jul 10, 2016 10:57PM ET
It’s not easy to find value stocks. Being aware of a company's key financial numbers – like earnings per share and sales growth – can help investors identify stocks that are trading for less than they're worth. However, a proper analysis of the fundamentals with the help of a number of metrics is required to determine whether a stock is a good bargain or not.
Among various value ratios, the price-to-book ratio (P/B ratio) is an easy-to-use tool for identifying low-priced stocks which have high-growth prospects.
The P/B 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.
Keeping the Basics Clear
To begin with, it is important to understand what book value is. Book value is the total value that would be left over, according to the company’s books of account, if it were to go bankrupt immediately. In other words, this is what shareholders would theoretically receive if a company liquidated all its assets and paid off all its liabilities.
It is calculated by subtracting total liabilities from total assets of a company. In most cases, that would equate to the 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 the book value.
Now coming back to the P/B ratio, by comparing book value of equity to its market price, we get an idea of whether a stock is under- or overpriced. However, like price to earnings (P/E) or price to sales (P/S) ratio, it is always better to compare P/B ratios within industries.
A P/B ratio less than 1 means the stock is trading at less than its book value, which can also mean the stock is undervalued. Conversely, a stock with a ratio greater than 1 can be interpreted as being overvalued or relatively expensive.
But there is a caveat. A P/B ratio less that 1 can also mean that the company is earning weak or even negative return on its assets, in which case the stock should be shunned. Conversely, the stock’s share price may be significantly high – thereby pushing the P/B ratio to more than 1 – 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 its limitations. It is useful for businesses – like finance, investments, insurance and banking – with many liquid/tangible assets on their books. However, it can be misleading for firms with large R&D expenditures or high-debt companies or those with negative earnings.
In any case, P/B used in isolation can’t pull off the trick. One should also analyze other ratios like P/E, P/S, and debt to equity before arriving at a reasonable investment decision.
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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 robust 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.
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