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Many value investors will look at stocks trading below their book value, or a P/B multiple below 1.0x, as a potential sign of deep value. The thinking goes that book value (shareholder's equity) is the conservative, accounting number of what the company's equity value is worth. If the stock's current market value is below even its accounting book value, then the stock could be potentially undervalued. There are pros and cons to this approach, which we will cover in this article. We will then look at five stock ideas currently trading below book value that may be worth adding to your portfolio.

Pros and Cons of Book Value

Let's first dig a little deeper into the trade-offs of using book value as a proxy of what a company should be worth. Book value represents the original cost of the equity, but not necessarily the current value of equity. For example, if you originally paid $100,000 for your home 15 years ago, but the current 2013 appraised value of your home is now $200,000, would you sell your home for only the original paid amount of $100,000? Note however, this argument also works the other way; the original price paid for something (home or a stock) could also be significantly higher than current value (say if you bought that home at the peak of real estate in 2006 for $300,000, now it's only worth $200,000).

Note that accounting book value is derived based on man-made accounting rules and policies that attempt to guide companies on what assumptions they can use to record their book value. If the assumptions (inputs) used in determining book value are incorrect, then the output (book value as a reflection of true value) is incorrect. As the saying goes, "garbage-in / garbage-out."

For example, banks hold a large number of financial assets on their balance sheets (besides just customer deposits), including CMBS, RMBS, swaps, derivatives, etc. During the financial crisis in 2007-2008, the values of these mortgage products and complex derivatives were eventually discovered to be worth just a fraction of what they were recorded as on the bank's balance sheet. As a result, the banks had to write-off losses on these investments, which significantly lowered the bank's book values. In this case, if you believed the book values of the banks at that time, you would have been burned badly.

As result, because of the complexity and assumptions required to derive book value in financial companies (banks, insurance companies, etc.), I will avoid looking at those companies and industries for this analysis. Don't get me wrong, it's still possible to find value stocks based on book value in the financial sector. It's just way more complicated and requires individually valuing every single asset/investment that the company owns on its balance sheet (for example, Genworth (GNW) trades at just 0.25x book value, but it also owns mortgage insurance products and obligations that are difficult to value).

Below are five stocks currently trading below book value that potentially could be value plays. High level summary of each stock is provided.

Hess Corporation (HES)

Hess Corporation is an integrated, oil and gas company with both upstream (exploration and production) and downstream (refining and marketing) operations. In 2011, year-end proven reserves totaled 1.5 billion barrels of oil equivalents. The company's downstream operations comprise of over 1,300 HESS gas stations and an oil refinery in New Jersey. Hess Corporation trades at 0.89x book value, with a market cap of $18.4 billion. The company's 2013E P/E is 7.8x, Net Debt / TEV is 28.5% and the dividend yield is 0.74%. HES has invested in the past 10+ years in high risk/high reward exploration (its leading position in the Bakken Shale), which could finally be coming into fruition. The CEO John Hess owns 11% of the company (executives and board members own 24% collectively), and John Hess made several large purchases in 2012 averaging around $50 per share.

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Corning (GLW)

Corning is a leading manufacturer of glass products found in LCDs, consumer electronic products (Gorilla Glass), fiber-optic cables, automobiles, and life sciences products, with the company controlling nearly 50% of the glass panel market globally. Corning trades at 0.89x book value, with a market cap of $19.5 billion. The company's 2013E P/E is 9.5x, with a dividend yield of 2.5% and net cash of $1.94 per share.

The stock could be a good cyclical play on the rebound of the LCD panel industry. LCD prices have declined for the past two years, but have finally stabilized in the past few months. In addition, the typical seven-eight year TV replacement cycle will be kicking in starting 2014 or possibly sooner (LCD TV purchases hit a peak in 2007). Finally, Corning's Gorilla Glass product, used in smartphones and tablets, is now a $1 billion a year business (13% of total sales). If interested, I have another article written recently on GLW with a much deeper analysis.

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Alcatel-Lucent (ALU)

Alcatel-Lucent is a leading, global telecom equipment provider operating in over 130 countries. ALU trades at 0.73x book value, with a market cap of $3.2 billion. ALU has net debt/TEV of just 2.9%, but note that ALU also has $8 billion of pension liabilities. The company is projected to lose money this year, with 2013E EPS of -$0.08 (note that the future net losses will also lower future book value). The company recently announced a new refinancing and cost reduction plan to help address liquidity concerns and get the business profitable again. ALU trades at just 0.2x revenue, compared with Ericsson (ERIC), which trades at 0.8x-1.0x revenue. ALU's patent portfolio (29,000 patents) alone could be worth $6.5 billion or more, compared with ALU's current market cap of just $3.2 billion. ALU is a high risk/high reward type of play, if it reduces costs and survives until telecom spending picks up again.

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Arkansas Best (ABFS)

Arkansas Best is a trucking company with 20,000 trailers and 4,000 tractors offering less-than-truckload (LTL) freight services in North America. The LTL market is a $50 billion industry (ABFS has about 5% market share) and includes competitors such as FedEx (FDX), UPS and YRC Worldwide (YRCW). In June 2012, ABFS acquired Panther Expedited Services for $180 million (acquisition multiple: 0.8x sales and 7x EBITDA). ABFS currently trades at 0.5x book value, with a market cap of just $250 million (2013 sales are $2.3 billion, implying just a 0.1x revenue multiple). The company's 2013E P/E is 15.9x and its dividend yield is 1.2%.

The biggest issue affecting ABFS is its labor costs and pension liabilities. Salary and wages is the largest cost component for ABFS, representing 60% of sales. Its current labor agreement with the Teamsters expires March 2013. Fuel cost is another significant cost component at 15% of revenue, but ABFS can generally pass through rising fuel costs to shippers. If ABFS can negotiate a new labor agreement with favorable terms in March 2013, the stock could react positively.

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Charm Communications (CHRM)

Charm Communications is a leading advertising agency in China. The top-five ad agencies in China in 2011 were WPP (WPPGY), Publicis (OTCQX:PUBGY), Aegis Media, Omnicom (OMC) and Charm. Charm has been the largest ad agency for CCTV (China's largest TV network) for 10 consecutive years, representing approximately 25% of CCTV's prime-time market share. Charm currently trades at 0.6x book value, with a market cap of $140 million. The company also has $118 million of net cash, meaning if you net out the cash, you're looking at a value of just $22 million for the business, or just 0.1x book value and about 0.1x 2013E sales of $183 million.

Chinese stocks have been out of favor with U.S. investors recently, given potential accounting issues, VIE structure concerns, and a potential China slowdown. In addition, CHRM changed it revenue segment mix in 2012 and has very low daily volume, which are additional risks you need to consider. However, with a current value of just $22mm for the business after adjusting for cash (which implies just 4.0x 2013E P/E after cash), the stock looks too cheap to ignore at current levels.

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Source: 5 Stocks Trading Below Book Value