Finding the right stock to invest in always requires a lot of legwork. New investors usually don’t know where to start. With the overflow of information that anyone can read online, investors experience a deluge of useful information before even finding a stock where they can be comfortable investing. But if you are looking for possibly undervalued companies, then Price to Book Value may be for you.
What is the Price to Book Value?
Price to book value or P/B is the ratio between a company’s share price over its book value of equity, as shown in the formula below. Book Value shows the difference between the value of a company’s assets and its book value of liabilities. Price to book value is one of the methods value investors would use to gauge if a company is overvalued or trading more than its book value.
When looking at a P/B standpoint, a high P/B ratio implies that a company may be overvalued, and a lower P/B implies that the company may be undervalued. The rule of thumb is that if a company’s P/B is lower than 1, its P/B suggests that the stock is trading at a discount relative to its intrinsic value.
Using price-to-book value to evaluate stocks
P/B can be a good place to start if an investor is trying to scour and find undervalued names. When companies have a low price-to-book ratio, it means that it is trading for less than their book value, and investors are paying less than their assets. This can mean that the market has not yet priced in what the company is worth. Finding these diamonds in the rough will help provide any investor with long-term growth and returns in their portfolio.
Another way of using P/B value is to combine it with other valuation metrics to find high-quality stocks. For example, suppose you also look at the return on equity (ROE). In that case, this can give you a better idea of a company’s growth prospects as this refers to the profit generated from shareholders’ equity in the company. A wide gap between the two could help investors avoid overvalued stocks. Investors may also use the dividend yield to find value stocks that provide a steady stream of income, even though the stock is intended for a long-term portfolio, the dividend can provide investors with a higher total return in the long run.
Now, look at some low P/B stocks that you can include in your watchlist.
Transocean Inc. (RIG)
Price to Book: 0.46
Transocean Ltd. is a company that provides international offshore contract drilling services for oil and gas wells. The company’s core business is focused on contracting its drilling rigs, work crews, and related equipment to drill oil and gas wells. As of February 9, 2017, the company owned or had partial ownership interests in 56 mobile offshore drilling units, and their fleet at that time consisted of:
- 30 floaters
- 7 harsh environment floaters
- 3 deepwater floaters
- 6 midwater floaters
- 10 high-specification jackups
Additionally, they had four ultra-deepwater drillships and five high-specification jack-ups that were either under construction or under contract to be constructed.
The company’s contract drilling services operations are spread worldwide across oil and gas exploration and development areas. In contrast, its drilling fleet can be characterized as floaters, including drillships and semisubmersibles, and jack-ups.
Danaos Corporation (DAC)
Price to Book: 0.49
Danaos Corporation is an international owner of containerships, chartering its vessels to a range of liner companies, and operates as a holdings company. The company's focus of business is the acquisition and operation of vessels.
The company operates through its vessel-owning companies, whose primary activity is the ownership and operation of containerships under the company’s managed companies. The company’s fleet of over 50 containerships has an aggregate of approximately 329,590 twenty-foot equivalent units (TEUs).
Danaos Corporation also has containership fleets that include about 53 containerships deployed on time charters and about two containerships deployed on bareboat charters. The company also owns Gemini Shipholdings Corporation (Gemini), which owns approximately four additional containerships of over 24,000 TEU aggregate capacity.
SkyWest, Inc. (SKYW)
Price to Book: 0.68
SkyWest, Inc. is a holdings company that owns SkyWest Airlines, Inc. (SkyWest Airlines), which offers passenger service to locations in the United States, Mexico, and Canada. The company has 2 operational segments, which include:
- SkyWest Airlines - this segment includes revenue earned under the company’s capacity purchase agreement attributed to operating aircraft and its respective operating costs.
- SkyWest Leasing - this segment includes the revenue earned from relevant capacity purchase agreements associated with the ownership of newly acquired aircraft through debt issuance and the corresponding depreciation and interest expenses incurred for those aircraft.
The company offers scheduled passenger and air freight service with approximately 1,620 daily departures to the United States, Canada, and Mexico destinations. The company’s flights are operated as Delta Connection, United Express, American Eagle, or Alaska Airlines flights.
Limitations of the price-to-book Ratio
Even though P/B can provide a quick way of seeing that a company is undervalued, investors should still be aware of its limitations. There will be instances where companies with low P/B ratios can be value traps. A value trap is when a company reports low or negative returns and would look like a good bargain because of its lower price and low P/B ratio. Still, realistically, it does not have any of the characteristics needed for capital appreciation over the long term, like a strong business model, growth prospects, etc.
Another important thing to note is that the P/B ratio is most effective when used on companies with tangible assets. If a company has mostly intangible assets, it would be more difficult to understand its book value and P/B ratio.
For example, companies are heavily reliant on their business brand names, copyrights, and patents (Pharma, Services, etc.) as the company assets that appear on their balance sheet won’t indicate their true value.
Final thoughts
Price to Book value will always be in most value investors' analysis tools. Being one of the metrics looked at by investment legends, you may think you can never go wrong. However, as time passes and technology hastens the transfer of information, it also shows the flaws of using only a single metric for investing. It is important for investors to always evaluate their potential investments on a fundamental and qualitative basis to ensure that proper risk management is considered. Some companies are undervalued based on their Price/Book value for a reason - and can remain undervalued for longer.
On the date of publication, Rick Orford did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
