Beating the market is tough, but finding quality stocks is even harder
Book value is a metric often used by value investors
We look at how the Price to Book Value ratio could uncover undervalued stocks
Investors are always on the lookout for strategies to outperform the market, yet the reality is that such shortcuts are often elusive.
Beating the market is notoriously challenging, and identifying high-quality stocks is even more so.
But in the quest for reliable methods to gauge a company’s real worth, one fundamental metric has stood out over the years: book value.
Many investors have been drawn to this metric due to its simplicity and the success stories of value investors like Warren Buffett, who famously amassed significant wealth in his early days by buying stocks that traded below their book value.
So what exactly is book value and how can today’s investors leverage it for success?
Book value defined
Book value is essentially a company’s equity value as reported in its financial statements.
It represents the total value of a company’s assets minus its liabilities.
So, at its most basic level, book value is the total value shareholders would theoretically receive if a company were liquidated, without taking into account the current share price.
Calculating book value is pretty simple:
Book value = total assets minus total liabilities
Total assets include both physical things like property and equipment, and intangible ones such as patents, trademarks, and goodwill. Note that items like depreciation is often factored in to align it with the actual value of the business.
Total liabilities, on the other hand, are the financial obligations that a company owes to external parties.
They comprise current liabilities, like accounts payable and accrued expenses, as well as long-term liabilities such as bonds payable and debt that extends over a longer period.
Introducing the price-to-book ratio
While book value serves as a helpful tool, it does not tell you anything about whether a stock is over or underpriced.
A more accurate approach, therefore, is to consider both the book value and how it compares with the current market value of the company.
The price-to-book ratio (P/B ratio) is the crucial metric that’s used for this purpose.
Value investors like Buffett have used the P/B Ratio extensively to assess whether a stock is fairly valued.
Price-to-book ratio = current share price / book value per share
Or simply:
Price-to-book ratio = market cap / book value
But before analysing a company’s P/B ratio, investors should consider one key factor: the current share price actually reflects the market perception of a company’s equity value in the future, not present.
Stock price is considered forward-looking because it reflects investors’ expectations about a company’s future earnings and cashflows.
In contrast, the book value is based on historical costs and may not accurately represent their current market worth of the company’s assets and liabilities.
A “good” P/B Ratio
When the P/B ratio is above 1, it suggests that investors are currently willing to pay more for the company’s assets than what they are currently valued on the balance sheet.
Conversely, when the P/B ratio is below 1, it suggests that investors can buy the company’s assets for less than what they are valued on the balance sheet, providing a margin of safety.
As a rule of thumb, value investors view a price-to-book (P/B) ratio below 1 as a sign of an undervalued stock.
On the other hand, while a high P/B ratio may indicate that a stock is overvalued, it could also indicate that investors are willing to pay a premium for the company’s assets. This might be because they believe in the company’s growth prospects. So a high P/B ratio is not necessarily a bad thing.
Different industries have varying P/B ratios. For example, tech or biotech stocks may have higher P/B ratios due to the value of their intellectual property and growth potential.
A note from the American Association of Individual Investors gave this general advice:
“If you’re trying to decide what a good price-to-book ratio is, you can think of this rule of thumb: Look for a price-to-book ratio of 2 or lower, though 1.25 or lower is even better.
“A well-managed company trading at a significant premium to book value (price-to-book ratio of greater than 4) should be watched but is only suitable for speculative trading until the valuation becomes reasonable.
“A company that is not well managed should never be purchased for any reason.”
Some ASX small caps with P/B Ratio of less than 1
Here’s a list of ASX small caps of less than 1. This list is by no means comprehensive.
Source: Commsec
Code Name Price/Book Ratio EXP Experience Co 0.94 EMN Euro Manganese Inc 0.94 BGE Bridge SaaS 0.94 PIA Pengana Equities 0.93 MGX Mount Gibson Iron 0.93 PEN Peninsula Energy 0.93 UCM USCOM 0.93 RKT RocketDNA 0.93 BM8 Battery Age Minerals 0.93 PMC Platinum Capital 0.92 GBE Globe Metals & Mining 0.92 ZNC Zenith Minerals 0.92 MHJ Michael Hill 0.92 NUC Nuchev 0.92 PLG Pearl Gull Iron 0.92 IG6 Graphite 0.92 BIM Bindi Metals 0.92 CWP Cedar Woods Properties 0.91 ORN Orion Minerals 0.91 NAE New Age Exploration 0.91 CUF CuFe 0.91 RMX Red Mountain Mining 0.91 GAL Galileo Mining 0.91 KAU Kaiser Reef 0.91 BTE Botala Energy 0.91 BPH BPH Energy 0.9 TRI TrivarX 0.9 IXR Ionic Rare Earths 0.9 AMI Aurelia Metals 0.9 DKM Duketon Mining 0.9 RYD Ryder Capital 0.9 ASG Autosports 0.9 CEH Coast Entertainment 0.9 AIM Ai-Media Technologies 0.9 MYS MyState 0.89 ABX ABx 0.89 FEG Far East Gold 0.89 RND Rand Mining 0.88 IEC Intra Energy Corporation 0.88 CSX CleanSpace 0.88 AMO Ambertech 0.87 PCG Pengana Capital 0.87 YPB YPB 0.87 SFX Sheffield Resources 0.87 OVT Ovanti 0.87 GSM Golden State Mining 0.87 BMM Balkan Mining and Minerals 0.87 RLF RLF AgTech 0.87 APZ Aspen 0.86 AVH AVITA Medical 0.86 EBG Eumundi 0.86 FWD Fleetwood 0.86 SHN Sunshine Metals 0.86 WWI West Wits Mining 0.86 VKA Viking Mines 0.86 INF Infinity Lithium 0.86 CTQ Careteq 0.86 APS Allup Silica 0.86 DYM Dynamic Metals 0.86 IPC Imperial Pacific 0.85 WNR Wingara Ag 0.85 ECS ECS Botanics 0.85 LIO Lion Energy 0.85 TNC True North Copper 0.85 NGX NGX 0.85 AKG Academies Australasia 0.84 VRS Veris 0.84 BC8 Black Cat Syndicate 0.84 STN Saturn Metals 0.84 PR1 Pure Resources 0.84 CC9 Chariot Corporation 0.84 OBL Omni Bridgeway 0.83 AAP Australian Agricultural Projects 0.83 MCT Metalicity 0.83 FFF Forbidden Foods 0.83 AUN Aurumin 0.83 RWL Rubicon Water 0.83 B4P Beforepay 0.83 GUL Gullewa 0.82 RMC Resimac 0.82 REZ Resources & Energy 0.82 PNX PNX Metals 0.82 MXO Motio 0.82 VTI Visioneering Technologies 0.82 RZI Raiz Invest 0.82 AMS Atomos 0.82 SER Strategic Energy Resources 0.82 NFL Norfolk Metals 0.82 DES DeSoto Resources 0.82
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