Given the surge in equities over the past three months, fears of overvaluation are rife. Therefore, it would be prudent to ensure a value quotient in your investment strategies. In value stock analysis, most investors use the P/E ratio to look for lucrative stocks, but there are other ratios an investor may consider such as the price-to-sales (P/S) ratio and the price-to-book (P/B) ratio.
The P/S ratio is simply price divided by sales. One of the reasons the price to sales ratio is a better choice is that it looks at sales rather than earnings like the P/E ratio does. However, the price to book ratio (P/B ratio) , although used less often, is also an easy-to-use valuation tool for identifying low-priced stocks with excellent returns.
The P/B ratio is calculated as follows:
P/B ratio = market capitalization / book value of equity
What is book value?
There are several ways to define book value. Book value is the total value that would remain, according to the company’s balance sheet, if it went bankrupt immediately. In other words, it’s what shareholders would theoretically receive if a company liquidated all of its assets after settling all of its liabilities.
It is calculated by subtracting the total liabilities from the total assets of a business. In most cases, this equates to common shareholders’ equity on the balance sheet. However, according to the company’s balance sheet, intangible assets must also be subtracted from total assets to determine book value.
Understanding the P/B ratio
By comparing the book value of equity to its market price, we get an idea if a company is undervalued or overvalued. However, like the P/E or P/S ratio, it is always best to compare P/B ratios within industries.
An AP/B ratio of less than one means the stock is trading at a price below 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 we pay $2 for every $1 of book value. Thus, the higher the P/B, the more expensive the stock.
But there is a caveat. An AP/B ratio of less than one can also mean that the company is earning low or even negative returns on its assets, or that the assets are overvalued, in which case the stock should be avoided as it can destroy shareholder value. Conversely, the price of the stock may be significantly high – thereby pushing the P/B ratio to more than one – in the likely event that it has become a buyout target, reason enough to hold the stock. .
Moreover, the P/B ratio is not without limits. It is useful for businesses – like finance, investments, insurance and banking or manufacturing companies – with many liquid/tangible assets on the books. However, this can be misleading for companies with large R&D expenses, high debt, service companies, or those with negative earnings.
In any case, the ratio is not particularly relevant as a stand-alone number. Other ratios like P/E, P/S and debt to equity should be analyzed before arriving at a reasonable investment decision.
Price to Book (common Equity) below the X-Industry median:A lower P/B relative to the industry average implies that there is enough room for the stock to win.
Selling price below median X-Industry:The P/S ratio determines how much the market values every dollar of the company’s sales/revenue – a lower ratio than the industry makes the stock attractive.
Price/earnings ratio using F(1) estimate below industry median X: The P/E (F1) ratio 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 relates the P/E ratio to the future growth rate of the company. The PEG ratio gives a more complete picture than the P/E ratio. A value below 1 indicates the stock is undervalued and investors should pay less for a stock that offers good earnings growth prospects.
Current price greater than or equal to $5: They must all trade at a minimum of $5 or more.
Average volume over 20 days greater than or equal to 100,000: Substantial trading volume ensures that the stock is easily tradable.
Zacks rating less than or equal to #2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform regardless of the market environment.
Value Score of A or B: Our research shows that stocks with a Value Score of A or B when combined with a Zacks #1 or 2 rank offer the best opportunities in the value investing space .
Here are five of the eight stocks that qualified for screening:
Alexion Pharmaceutical ALXN, a leading biotech, has a 3-5 year EPS growth rate of 17.8%. He currently has a Zacks rank #2 and a value score of B. You can see the full list of today’s Zacks rank #1 stocks here.
Adient S.A. ADNT, the world’s largest supplier of automotive seats, has forecast an EPS growth rate of 32.1% over 3 to 5 years. He currently has a Zacks rank No. 2 and a value score of B.
Affiliate Managers Group AMG, a global asset manager, is currently a No. 2 ranked stock in Zacks. It has a 3-5 year EPS growth rate of 15% and a value score of A.
Canadian Solar CSIQ, a solar company, forecast a 3-5 year EPS growth rate of 32%. He currently has a Zacks rank No. 2 and a value score of B.
Meritage Homes MTH, a home building company, has a Zacks Ranking #2 and a value score of A. The company has an expected EPS growth rate of 20.7% over 3-5 years.
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Canadian Solar Inc. (CSIQ): Free Stock Analysis Report
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