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
The P/B ratio reflects how many times book value investors are ready to pay for a share. Therefore, if the share price is $10 and the 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.
The P/B ratio helps to identify low-priced stocks with high growth prospects. Solo Brands DTC, Park Hotels & Resorts PK, Flex Ltd. FLEX, Centene CNC and Deluxe Corporation DLX 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 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 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 the five picks that qualified the screening:
Headquartered in Southlake, TX, Solo Brands is a direct-to-consumer platform, which offers outdoor and lifestyle-branded products directly to consumers, primarily online. Its products are camp stoves under the Solo Stove Lite brand name; fire pits under the Solo Stove brand name; kayaks under the Oru brand name; paddle boards under the ISLE brand name; and storage solutions for fire pits, firewood and other accessories.
Solo Brandscurrently 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.
Solo Brandshas a projected 3-5-year EPS growth rate of 11.65%.
Mc Lean, VA-based Park Hotels & Resorts is a lodging real estate company. The company has a diverse portfolio of iconic and market-leading hotels and resorts in the United States and the international markets.
PK presently sports a Zacks Rank #1 and has a Value Score of A. The company has a projected 3-5-year EPS growth rate of 7.95%.
Singapore-based Flex offers advanced manufacturing solutions and supply-chain services throughout the product lifecycle development, including fulfillment, after-market support and circular economy solutions. Flex serves companies of all sizes in various industries and end markets, including medical, automotive, industrial, home appliances, capital equipment, energy, telecom, networking, enterprise computing, wearables, connected living and mobile.
FLEX currently flaunts a Zacks Rank #1 and has a Value Score of A. PK has a projected 3-5-year EPS growth rate of 12.39%.
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, appropriate healthcare services.
Centene has a projected 3-5-year EPS growth rate of 12.83%. CNC currently has a Zacks Rank #2 and a Value Score of A.
Headquartered in Minneapolis, MN, Deluxe Corp provides technology-enabled solutions to enterprises, small businesses and financial institutions in the United States, Canada, Australia, South America and Europe.
Deluxe Corp has a Zacks Rank #2 and a Value Score of A at present. DLX has a projected 3–5-year EPS growth rate of 12.0%.
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