Even in the best of times, the stock market can prove to be an erratic and unpredictable place. Stocks that once seemed to be the unparalleled champions of Wall Street can take sudden, unexpected tumbles, shedding their once-glamorous positions to become troubling eyesores in investors' portfolios.
From the individual investor's point of view, the challenge is to avoid these potential pitfalls from the beginning by attempting to identify the stocks least likely to suffer serious share-price declines in the future. Unfortunately, this is all-too-easy to say, and extremely difficult to do. A myriad of factors can affect the future value of any given company, making the task of predicting the future for a single stock - let alone an entire portfolio - unbelievably difficult for the individual investor.
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Find a Better Future With Book Value
That said, focusing on a few key factors will go a long way toward reducing your chances of ending up with an eyesore portfolio in the future. Research has shown that stocks purchased with low price-to-book (P/B) ratios will, on average, have less downside risk than the average stock and tend to outperform the overall market average as well. (Learn more about book value in Digging Into Book Value.)
In fact, it is this basic (yet powerful) strategy that was employed successfully by none other than Benjamin Graham, who is generally considered to be the creator of the value investing discipline. Graham was famous for only buying stocks that traded at prices that were less than two-thirds of their book values. His reasoning was that while any given stock with a low P/B ratio could end up being a loser, an entire portfolio of low P/B stocks would, on average, do quite well. (To learn more about Benjamin Graham, read The Intelligent Investor: Benjamin Graham.)
Everyone Wants a Bargain
The problem is that buying stocks under book value isn't always easy. Savvy investors are already aware of this strategy so when such bargains arise, they are often scooped up in short order. The widespread use of screening technology by retail and institutional investors has eliminated much of the detective work that Graham was forced to do during his time. (To learn more, read Getting To Know Stock Screeners.)
It is important to note that this method of investing is not a guarantee for success. In fact, sometimes "cheap" stocks remain cheap, often for good reason. It may take many years for the masses to appreciate them, or they may never be discovered at all. Some companies that trade below their book values deserve to because they may have problems and will never be industry leaders.
Five Stocks With Low P/B Valuations
Let's check out some stocks that are trading at a price-to-book ratio of less than 1, and which may be worthy of follow-up research. Here are four stocks with low P/B ratios that may have the potential to generate excess returns.
|Bank of America (NYSE:BAC)||114.79B||0.5||7.78|
|Toyota Motor Corp. (NYSE:TM)||112.43B||0.90||19.12|
The Bottom Line
Despite all the technological advances the markets have seen since the days of Ben Graham, the lessons he provided still hold true to this day. A simple metric such as P/B value can provide individual investors with a great lead in the search for undervalued stocks.
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