There are several different ways to find value stocks. Among these, the most popular are the price-to-earnings ratio (P/E) and the price-to-sales ratio (P/S). However, investors often overlook the price-to-book ratio (P/B ratio), which, though used less often, is also an easy-to-use valuation tool for identifying low-priced stocks with great returns.
The P/B ratio is calculated as below:
P/B ratio = market capitalization/book value of equity
The P/B ratio helps identify low-priced stocks with high growth prospects.
Here we discuss five stocks with a low P/B ratio and a “Buy” recommendation. These are BioMarin Pharmaceutical BMRN, General Motors GM, Harmony Biosciences HRMY, Adient plc ADNT and Gibraltar Industries ROCK.
Now, let us understand the concept of book value.
There are several ways in 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 went 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 total assets to determine book value.
By comparing the book value of equity to its market price, we get an idea of whether a company is under- or overpriced. Like P/E or P/S ratios, it is always better to compare the P/B ratio 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 such a 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 five of the 11 stocks that qualified the screening:
San Rafael, CA-based BioMarin Pharmaceutical focuses on the development and commercialization of treatments for life-threatening severe medical conditions, mainly for children.
BMRN has a Zacks Rank #2 and a Value Score of A. BioMarin has a projected 3-5-year EPS growth rate of 20.11%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Headquartered in Detroit, General Motors is one of the world’s largest automakers. General Motorshas a projected 3-5-year EPS growth rate of 10.65%.
GM currently has a Zacks Rank #1 and a Value Score of A.
Headquartered in Pennsylvania, Harmony Biosciences is a pharmaceutical company making therapies for rare neurological disorders. Harmony Biosciences currently has a Zacks Rank of 2.
HRMY has a Value Score of A and a projected 3-5-year EPS growth rate of 25.66%.
Dublin, Ireland-based Adient is one of the world’s largest automotive seating suppliers. It designs, manufactures and markets seating systems and components for passenger cars, commercial vehicles and light trucks, including vans, pick-up trucks and sport/crossover utility vehicles.
ADNT presently has a Zacks Rank #2 and a Value Score of A. The company has a projected 3-5-year EPS growth rate of 15.7%
Buffalo, NY-based Gibraltar Industries manufactures and distributes products to the industrial and building markets. The products range from ventilation and expanded metal to mail storage solutions and rain dispersion products and solutions.
Gibraltar Industries has a Zacks Rank #2 and a Value Score of A. ROCK has a projected 3-5-year EPS growth rate of 15.0%.
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BioMarin Pharmaceutical Inc. (BMRN) : Free Stock Analysis Report
General Motors Company (GM) : Free Stock Analysis Report
Gibraltar Industries, Inc. (ROCK) : Free Stock Analysis Report
Adient (ADNT) : Free Stock Analysis Report
Harmony Biosciences Holdings, Inc. (HRMY) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
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