It’s not an easy job to find value stocks. Being aware of a company's key financial numbers, like earnings per share and sales growth, can help investors identify stocks that are trading for less than what they're worth. However, a proper analysis of the fundamentals with the help of a number of metrics is required to determine whether a stock is a good bargain or not.
For narrowing down the list of undervalued stocks, price to earnings (P/E) and price to sales (P/S) are the first ratios that come to an investor’s mind. However, the price-to-book ratio (P/B ratio), though underrated, is also an easy-to-use valuation tool for identifying low-priced stocks with high-growth prospects.
The P/B ratio is calculated as below:
P/B ratio = market capitalization / book value of equity
What is Book Value?
To begin with, it is important to understand what book value is. 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 the 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 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.
But there is a caveat. A P/B ratio 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 share 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 isn't 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 expenditures, high-debt companies, service companies or those with negative earnings.
In any case, the ratio is not particularly relevant as a standalone number. One should also 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 ratio links the P/E ratio to the future growth rate of the company. 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 prospect.
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 Style 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 14 stocks that qualified the screening:
General Motors Company GM, a leading global automotive company, has a projected 3-5 year EPS growth rate of 8.37%. Currently, the stock has a Value Score of A and a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
ArcelorMittal MT, a leading steel and mining company, has Zacks Rank #1. It has a 3-5 year EPS growth rate of 13.4% and a Value Score of A.
Volkswagen Aktiengesellschaft VLKAY, a European automobile manufacturer, has a Zacks Rank #2. It has a 3-5 year EPS growth rate of 18.7% and a Value Score of A.
Horizon Pharma Public Limited Company HZNP is a biopharmaceutical company with a projected 3-5 year EPS growth rate of 16.5%. Currently, Citizens Financial has a Zacks Rank #2 and a Value Score of A.
Lam Research Corporation LRCX is a leading global provider of innovative wafer fabrication equipment and services to the semiconductor industry. The company has a projected 3-5 year EPS growth rate of 14.9%. Lam Research has a Zacks Rank #1 and a Value Score of B.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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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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