Value investors actively seek out stocks that they believe the market has undervalued. They believe that the market overreacts to good and bad news, resulting in stock price movements that are inconsistent with a company’s long-term fundamentals. This, they believe, creates an opportunity to profit if the stock’s price falls. Value investors turn to financial metrics to analyze a company’s fundamentals.
Price-to-book (P/B) ratios are commonly favored by value investors to identify 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 follows:
P/B ratio = market price per share/book value of equity per share
Now let’s understand the concept of book value.
What is book value?
There are several ways book value can be defined. Book value is the total value that would be left on the company’s balance sheet if it were to file for immediate bankruptcy. In other words, this is what shareholders would theoretically get if a company liquidated all of its assets after paying off all of its liabilities.
It is calculated by subtracting total liabilities from total assets of a company. In most cases, this corresponds to the common shareholders’ equity on the balance sheet. However, depending on the company’s balance sheet, intangible assets may also need to be deducted from total assets to determine book value.
Understanding the 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 overvalued. However, it is always better to compare P/B ratios within industries, as well as the P/E or P/S ratio.
An AP/B ratio of less than one means the stock is trading below 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 overvalued or relatively expensive.
For example, a stock with a P/B ratio of 2 means we’re paying $2 for every $1 in book value. So the higher the P/B, the more expensive the stock.
But there is a caveat. An AP/B ratio of less than one can also mean that the company is making poor or even negative returns on its assets, or that the assets are overvalued. In this case, the stock should be avoided as it can destroy the value of the company. Conversely, the stock’s price can be significantly high — pushing the P/B ratio to more than one — in the likely event that it’s become a takeover target, a good reason to own the stock.
In addition, the P/B ratio is not without limitations. It is useful for companies – such as financial, investment, insurance and banking or manufacturing companies – with many liquid/tangible assets on the books. However, it can be misleading for companies with significant R&D spending, high levels of debt, service companies, or companies with negative earnings.
In any case, as a standalone number, the ratio is not particularly relevant. One should analyze other metrics such as P/E, P/S, and debt-to-equity before making a sound investment decision.
Price book value (share capital) smaller than X industry median:A lower P/B compared to the industry average implies that the stock has enough room to gain.
Selling price below X industry median:The price-to-earnings ratio determines how much the market values every dollar of the company’s sales/earnings — a lower ratio than the industry makes the stock attractive.
Price-earnings estimate using F(1) less than X-industry median: P/E (F1) values a company based on its current share price relative to its estimated earnings per share – a lower ratio than the industry’s is considered better.
PEG less than 1:PEG links P/E to the future growth rate of the company. The PEG ratio paints a more complete picture than the P/E ratio. A value less than 1 indicates the stock is undervalued and investors are paying less for a stock that has good prospects for earnings growth.
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 considerable trading volume ensures that the share can be traded without any problems.
Zacks rank less than or equal to #2:Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known for outperforming regardless of the market environment.
Value Score equals A or B: Our research shows that stocks with a Value Score of A or B combined with a Zacks Rank of #1 or #2 offer the best value investing opportunities.
Here are five of the 10 stocks that qualified for screening:
PVH Corp. PVH, a leading apparel retailer, has a 3-5 year EPS growth rate of 18.0%. It currently has a Zacks rank of #1 and a Value Score of A. You can see the full list of today’s Zacks ranked #1 stocks here.
USANA Health Sciences USNA: The company develops and manufactures high quality nutritional, personal care and weight management products. It has a projected 3-5 year EPS growth rate of 15.0%. It currently has a Zacks Rank #2 and a Value Score of A.
Adient plc ADNT, the world’s largest auto seat supplier, has a forecast 3-5 year EPS growth rate of 32.1%. It currently has a Zacks Rank #2 and a Value Score of A.
Celestica CLS, an electronics manufacturing services company, has a forecast 3-5 year EPS growth rate of 25.6%. It currently has a Zacks Rank #2 and a Value Score of A.
connections CONN, a Stockist, has a Zacks Rank #1 and a Value Score of A. The company has a forecast 3-5 year EPS growth rate of 23.0%.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options mentioned in this material.
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PVH Corp. (PVH): Free Stock Analysis Report
Conns, Inc. (CONN): Free Stock Research Report
Celestica, Inc. (CLS): Free Stock Research Report
USANA Health Sciences, Inc. (USNA): Free Stock Research Report
Adient PLC (ADNT): Free stock research report
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