The next value metric we will add to the current Magic Formula list is the price-to-book ratio. Previously, we've covered Magic Formula stocks with the:
Price-to-book is one of the oldest and most intuitive value investing statistics. The "bible" of value investing, Benjamin Graham's The Intelligent Investor, uses the price-to-book ratio as the main criteria for finding undervalued stocks. Book value is the same thing as net worth: all of a company's assets, minus its liabilities. The net worth is (ideally) what the company's value is when not adding a premium for things like future earnings power. Therefore, a company whose market value is below book value would seem to be an obvious bargain.
Through this series of articles we've also been using James O'Shaughnessy's study of mechanical investing strategies over 50 years, detailed in his book What Works on Wall Street. Buying stocks with low price-to-book ratio as the only criteria performed very well over the 50 year study period, behind only the price-to-sales ratio:
Of course, there are a few things to be aware of when buying stocks selling below book value. For one, the book value will be calculated with accounting assumptions made for certain assets such as the worth of intangibles like brand names, patents, exclusivity contracts, and so forth. Also, for many companies the purchase price of acquisitions over the acquired company's book value (known as "goodwill") will be a major portion of assets on the balance sheet, even though it is not an asset that can be bought and sold. Some investors prefer to subtract intangibles and goodwill out from the total assets to get what is known as a "tangible book value." However, not all of the book values used in the list below do this.
So, with no further ado, here are the 20 Magic Formula stocks with lowest price-to-book ratio:
|CITP||COMSYS IT Partners||0.31|
|NOV||National Oilwell Varco||0.67|
All 20 of these stocks sell below their stated net worth. Two of them are MagicDiligence Top Buys and a few others were given favorable reviews. As always, more research is required before trusting these ratios. For example, the top stock here, Ticketmaster (TKTM), has 63% of its total assets in goodwill and intangibles. Subtracting these out leaves a tangible price-to-book ratio of close to 1.0 - still pretty cheap but not nearly as impressive as 0.18. On the other hand, Hurco (HURC) has less than 3% of assets in intangibles and goodwill, making its valuation well below what the company is worth on a net asset basis, and probably worth a good look by value investors.
For the next and final article in this mini-series, we'll put all of the add-on metrics together, and create a list of Magic Formula stocks that rank highly when scored on each additional screen. Since Magic Formula stocks are cheap and high quality by design, this cumulative screen should help identify some of the very best MFI opportunities on a quantitative basis.
Disclosure: Steve owns NWS.