Key Takeaways
- PFE, GM, GBX, ITRI and STNE stocks are great buys for value investors, based on price-to-book ratio.
- Price-to-book ratio (P/B ratio) is measured by dividing market capitalization by the book value of equity.
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Value investors have preferred the price-to-earnings ratio or P/E since time immemorial as a means to identify value stocks. However, in the case of loss-making companies that have a negative price-to-earnings ratio, the price-to-sales or P/S ratio is considered while determining their true value.
However, the price-to-book ratio (P/B ratio), though used less often, is also an easy-to-use valuation tool for identifying low-priced stocks with great returns.
P/B is the ratio of stock price to book value.
It is calculated as below:
P/B ratio = market capitalization/book value of equity.
The P/B ratio helps to identify low-priced stocks with high growth prospects. Pfizer PFE, General Motors Company GM, The Greenbrier Companies GBX, Itron ITRI and StoneCo STNE 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 13 stocks that qualified the screening:
New York-based Pfizer is one of the largest drugmakers in the world, marketing a wide range of drugs and vaccines. Pfizer 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.
PFE has a projected 3-5-year EPS growth rate of 10.7%.
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 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 A at present. GBX has a projected 3-5-year EPS growth rate of 23.3%.
Liberty Lake, WA-based Itron is a technology and services company and one of the leading global suppliers of a wide range of standard, advanced, and smart meters and meter communication systems, including networks and communication modules, software, devices, sensors, data analytics and services to the utility and municipal sectors.
ITRI presently has a Zacks Rank #2 and a Value Score of B. The company has a projected 3-5-year EPS growth rate of 25.0%.
StoneCo provides financial technology solutions. The company offers an end-to-end cloud-based technology platform to conduct electronic commerce across in-store, online and mobile channels. StoneCo is based in Sao Paulo, Brazil.
STNE has a Zacks Rank #1 and a Value Score of B. STNE has a projected 3-5-year EPS growth rate of 23.5%.
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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.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance
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