P/B vs. P/E: Measuring a Stock's Value

When the market is pessimistic, one can buy good companies at discounts to their intrinsic values. What's a good way to tell if the market is pessimistic about a stock you're interested in? As we saw in the Chapter 7 summary of The Investment Zoo, Stephen Jarislowski suggests comparing a company's current P/E with its historical P/E to see if it trades at depressed levels. As seen here, we did this comparison for Coca-Cola (KO) over the last several decades to get an idea of where it currently trades.

However, for some firms, P/E is not the best measure of value. Consider companies or industries with very cyclical earnings. Since earnings fluctuate, P/E values can be distorted and thus can't be relied upon to provide meaningful data. Another useful method to compare a company's market valuation to its historic levels is using the price to book [P/B] values. P/B values are often considered useful for the financial industry, where the market value of a firm is heavily related to the value of its equity.

As an example, here's a look at historical P/B levels for several banks (JP Morgan (JPM), Citibank (C), Bank of America (BAC), and Wachovia (WB) which is in the midst of being taken over):

click to enlarge

We see that throughout the late 70s and early 80s, one could buy banks for less than the book value of their common equity. Once again, we see banks approaching those valuation levels.

Of course, one has to be cautious when considering this data. If book values are to drop (as they have been in this industry of late), then the P/B values in the above chart are currently overstated. As we discussed here, the use of leverage in the banking industry makes the value of equity particularly difficult to accurately measure. Nevertheless, these weaknesses of using P/B for the banking sector shouldn't discourage you from making historical P/B comparisons for companies in industries with stable book values and medium to low use of debt levels.

Disclosure: None

 

Comments

[5kDow:]

People have lost the ability to asset value and now we're seeing people looking for value get their heads handed to them.

2008 Oct 24 08:06 AM

[MichaelZZ:]

Resolution for Distressed “Reset” Mortgages:

Concepts:
1) One size does not fit all, i.e., each situation should be tailored for the borrower.
2) Responsibility should be resolved between the lender and the borrower.
3) No taxpayers’ funds should be involved.
4) A mortgagor must sign a document, subject to perjury, whereby the mortgagor states
that he or she was unaware that the interest rate was to be reset.

The mortgagor has the option of the following alternatives:
The mortgagor will be allowed to wind the clock back to the time prior to the purchase
with the information that the mortgage will be reset at the end of five years at a rate to
be determined and explained that the rate may be significantly higher than the rate
offered at the time of purchase.
1) Can agree to the purchase and will remain with the current situation.
2) Can refuse the 5/25 loan as offered and opt for a conventional fixed rate loan
at a rate of the then-current rate, e.g., 7.25% and will have all payments adjusted to reflect that loan.
3) Can terminate the potential purchase.
4) Can remain in the property, while making the same payments. The lender or agent thereof will be given a lien on the property that will be equal to the accumulation of the difference between the contractual payments and the payments being made. Further, interest will accrue on this differential at the contractual rate.

If the mortgagor opts for option 3), and there is no significant evidence reflecting that the
rate reset information was given prior to entering into the mortgage, the mortgagor will
vacate the premises and the mortgage will be cancelled, with no further obligation.
Any other encumbrance upon the property will be the responsibility of the mortgagor.
Further, the mortgagor will be responsible for any damages done to the property.


One of the most critical factors is the business model of a CountryWide negotiating mortgages, and then having them bundled and sold as securities. That "model" stimulated the numbers, since the negotiators were no longer involved with these mortgages.
The logistics of my idea would be to have the funds consisting of two pieces (one, the payment from the mortgagor, and the second, the augmented payment from the "negotiator", who will hold the 2nd) and the total would be paid to the "security" as a whole payment.
This would place the responsibilities where they should be, on the mortgagor and on a "CountryWide", i.e., the negotiator.
I would have argued this concept during the negotiations between the various AG's and Bank of America regarding the CountryWide resolution. I think the cost would be much less than the eight billion dollar settlement
If these logistics require some tweaking, so be it.

2008 Oct 24 08:20 AM

[jzjinvestor:]

Right on Michael!

2008 Oct 24 10:32 AM

[kdo:]

In general I agree with the sentiment of the article, especially when evaluating the market as a whole. However, when looking at an individual situation such as this, you obviously have to determine whether or not they will be an ongoing operating entity. Otherwise, your analysis would have said:

I should buy CFC, WM, BSC, LEH, AIG, WB, FNM, FRE, etc, etc. They have a low P/B!! Whoo hoo!!

In some ways you could approach this from a reverse angle. Note who in the banking sector amongst the fallen have much higher P/B ratios as a sign of a higher chance of remaining an ongoing operating entity which will benefit from the loss of the other cacasses.

2008 Oct 24 06:49 PM