Thursday, February 26, 2009

trading under book value

A Company's Book Value is defined by Investopedia as follows:
1. It is the total value of the company's assets that shareholders would theoretically receive if a company were liquidated.
2. By being compared to the company's market value, the book value can indicate whether a stock is under- or overpriced.

The Price to Book ratio is used to compare a stock's market value to it's book value. The following stocks have been beaten down to the point where their market price is actually less than their liquidation value (book value). Therefore in a way the company is getting little credit for any future earnings, and in fact the market is betting earnings will decline and is valuing the company at less than the sum of it's parts. Another way to look at it is that the market is betting that book value will decline due to company specific issues.

TD Bank (TD) 0.96x book
CP Rail (CP) 0.93x book
Petro Canada (PCA) 0.83x book
General Electric (GE) 0.86x book
Ford Motor (F) 0.75x book
Bank of Montreal (BMO) 0.81x book
Dow Chemical (DOW) 0.54x book

When you look at the Price to Book ratio for a stock it is important to note what assets the company owns and how they earn money. For example Microsoft (MSFT) has a very high Price to Book ratio of 4.4x because their main income source is from selling software that smart people develop in offices, versus Toyota Motor (TM) who manufactures automobiles in enormous facilities filled with expensive equipment and supplies; they have a low Price to Book of just over 1x.

Generally companies that own and market softer goods bearing well recognized brands and having competitive advantages will have higher Price to Book ratios. This contrasts against more economically sensitive firms, and hard goods firms who's goods or services trend more toward commodities and less towards brands and intellectual property.


Nurseb911 said...

There are a lot of companies trading at surprising discount to BV as earnings come down and price follows (P/E contraction). One important lesson I learnt from observing the 2000-2002 market was although many companies traded well below their book value the ones who were increasing their book value over that period of time did better in gains to their valuations when the market turned. There were a lot of companies value investors got tricked into buying based on low price-to-book that had declining book values over a 12-24 month period.

The stocks you've mentioned though, in the most part, should be companies that are able to increase their BV despite market conditions.

MG (moneygardener) said...

I think that book value gets a little fuzzy when companies derive earnings in the financial arena.

Anonymous said...

Book is only as meaningful as the valuation of the underlying assets. Are you saying that these companies are buys?

TD, for instance, has made 2 large acquistions in the US. What's their mortgage portfolio look like? We don't know yet. Personally, I'd still avoid this name.

GE. Any book valuation (at this point) cannot be trusted. Over 50% of GE was GE Financial. Nuff said.

Ford. Are you kidding me? Next....

Dow Chemical and CP Rail are probably the safest on the list.

Anonymous said...

Book Value and Liquidation Value are not the same thing. Intangible items carry no value during a liquidation sale.

Anonymous said...

Book Value and Liquidation Value are not the same thing. Case in point, Circuit City. Book Value Per Share was $6.40. Liquidation value was insolvent. Where did they end up? Answer: Insolvent.

Anonymous said...

As anon mentioned above BV <> LV and that definition from Investopedia is crap. Why you sourced it makes me wonder if you know what book value is or many of the considerations around using it as a valuation metric. Since MG didn't reply about BV I will suggest a silly simple case. Imagine firm A overpays by a factor of 2 for firm B (according to B's BV) the difference goes on A's balance sheet as goodwill. Since Mr Market knows A overpaid for B, the new BV of A is some number, the LV is some lower number. Make sense?