Key Takeaways
- Price-to-book ratio is a convenient tool for identifying low-priced stocks with high-growth prospects.
- Book value is what shareholders may receive if a company liquidates assets after paying off all liabilities.
- GM, IART, GBX, TRTX and ENS are stocks whose P/B ratios suggest they are strong buys right now.
Among the valuation metrics, price-to-earnings (P/E) and price-to-sales (P/S) are more commonly used for stock selection. This is because calculations based on earnings and, to some extent, sales are easy and handy. However, the price-to-book ratio (P/B ratio) has emerged as a convenient tool for identifying low-priced stocks with high-growth prospects.
The P/B ratio is used to calculate how much an investor needs to pay for each dollar of the 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, Integra LifeSciences IART, The Greenbrier Companies GBX, TPG RE Finance Trust TRTX and Enersys ENS 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.
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 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.
5 Low Price-to-Book Stocks
Here are five of the 11 stocks 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. GM has a projected 3-5-year EPS growth rate of 12.8%.
General Motors currently has a Zacks Rank #2 and a Value Score of A.
Headquartered in Plainsboro, NJ, Integra LifeSciences is one of the world leaders in regenerative medicine. The company develops, manufactures and markets cost-effective surgical implants and medical instruments. Integra LifeSciences currentlyhas a Zacks Rank #2 and a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
IART has a projected 3-5-year EPS growth rate of 12.0%.
Headquartered in Lake Oswego, OR, The Greenbrier Companies is a leading supplier of transportation equipment and services to the railroad and related industries. It also engages in complementary leasing and services activities.
The Greenbrier Companies has a Zacks Rank #1 and a Value Score of B at present. GBX has a projected 3-5-year EPS growth rate of 11.7%.
San Francisco-based TPG RE Finance Trust is a commercial real estate finance company. It focuses primarily on directly originating, acquiring and managing commercial mortgage loans and other commercial real estate-related debt instruments.
TPG RE Finance Trust presently has a Zacks Rank #2 and a Value Score of B. The company has a projected 3-5-year EPS growth rate of 33.2%.
Headquartered in Pennsylvania, EnerSys engages in manufacturing, marketing and distribution of various industrial batteries worldwide. It has a Zacks Rank #2 currently.
ENS has a Value Score of A. EnerSys has a projected 3-5-year EPS growth rate of 18.0%.
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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 that are 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 that are mentioned in this material.
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