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, Barel Karsan (419 clicks)
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As we've seen in previous posts, looking at a company's price to book (P/B) value can be a useful indicator as to how favorably the market is looking at a particular stock or group of stocks. Low P/B values can also offer investors downside capital protection in case earnings dry up. However, investors must be careful of putting too much faith in the actual book values of companies in which they are considering investing. Consider Circuit City (CCTYQ,PK).

A few months ago, Circuit City sought bankruptcy protection. Last week, the company declared that it is liquidating its stores. The company shows a book value of over $1 billion. So how much should equity holders expect following liquidation? According to acting president and CEO James Marcum:

The Company does not anticipate any value will remain from the bankruptcy estate for the holders of the Company's common equity, although this will be determined in the continuing bankruptcy proceedings.

The shares trade for just $5 million, despite the $1 billion value shown on the books! This represents a great example of how what's important is not what the book value is but rather what's in the book value. Circuit City's cash, accounts receivable, and inventory add up to $2 billion. While investors may have confidence in the value of these items for the most part, the value of the company's property, plant and equipment booked at $2.5 billion is much more uncertain. This number represents the company's historical cost for these items minus depreciation - it is not an indicator of what these items should sell for under liquidation.

The lesson here is that when looking for tangible downside capital protection in stock investments, a low P/B value itself does not guarantee protection. It's important to dig into the components of a company's book value to determine whether there are indeed assets that can be converted into cash. Ben Graham recognized this by estimating the liquidation values of companies by ignoring all fixed assets (i.e. current assets - all liabilities).

Disclosure: None

Source: Circuit City's Book Value: What's Real, What's Not?