When searching for a company that might satisfy my investing criteria, I’m looking for a situation where the market capitalization (current stock price multiplied by the number of outstanding shares) is less than the book value (equity) of the company. That is, I’m looking for a company where the stock market is pricing that company for less than the value being assigned to it by the internal accounting function. Thus, my P/B filter is set to under 1.0. My goal is to buy at a low price and that means buying all the equity I can get for my dollar. So, the P/B is the best place to start filtering for low-priced stocks, in my view.

Financial ratios serve as great filters toward enabling one to locate undervalued stocks. A fundamental analysis approach is one that emphasizes analyzing numbers over analyzing technical (stock) trading patterns to determine when to invest. If the goal is to buy at a low price, I can think of no ratio more key to fundamental analysis than the P/B ratio.

Yet, ratios are never complete when used in isolation. While the P/B ratio can be used to identify companies trading below their equity levels, that information alone cannot tell me whether the companies are financially healthy. It simply tells me, again, that the market is pricing the company for less than the equity shown on its balance sheet.

As discussed in my book, “Choose Stocks Wisely,” you can’t tell much from the “amount” of equity on the balance sheet without delving into the nature of the accounts that comprise that equity, namely the specific assets (resources) of the company and its liabilities (obligations). So before we can conclude that a stock is of interest, there’s simply more to do with regard to ascertaining the quality of the equity.

When I go to buy something, I want to get a good value for the dollar spent. That includes stock purchases. Intuitively, when I can buy a unit of equity (a share of common stock) for less than its probable worth, I’ve made a good investment. Since buying more than a dollar’s worth of equity for a dollar is what I’m after, again, using the P/B ratio as my initial filter just makes good sense.