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 its 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 (PCZ) 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 whose goods or services trend more toward commodities and less towards brands and intellectual property.

Comments

[Gino Verza:]

Just a corporate finance perspective:

Oversimplifying ----stock prices are low because of the the expectation that the Present Value of the future free cash flows (discounted at the weighted average cost of capital) generated by the assets will be lower than the initial investment amount (book value).

In other words, a price with a discount to book (other things being equal) means that the expected return from existing assets (book value) will be lower than the firm's weighted average cost of capital.

Oversimplifying ---regardless of the activity of the firm involved, a company with the expectation of insufficient free cash flow will exhibit a price with a discount to book.

MSFT has a relatively high price to book, because of the combination of free cash flow plus surplus cash on the balance sheet.

Feb 27 03:45 AM

[moneygardener:]

Gino I think you are oversimplifying. Price to book is not simply a reflection of financial wherewithall (free cash flow etc.). The ratio also reflects the earning power of assets that contribute to book. A tech firm will always have a higher price to book than a resource firm, regardless of their balance sheet.

Feb 27 11:20 AM

[GCherer:]

Just a rookie here, but does book value include 'goodwill'? If so, should a company liquidate, is there any 'goodwill' asset to distribute? E.G., Micro$oft has a jubongous amount of 'goodwill' on its books. How does it figure in the Price to Book computation?

Feb 27 01:08 PM

[Ricard:]

Well, this is a good first step for someone if they are not familiar with book value.

However, Gino's argument is valid. Most of these companies traded well above book at one point because the market valued the cash flows the assets on the book generated. Once that stream of cash disappeared, the company became valued under book.

Moneygardener, book has very little to do with earning power. There are plenty of tech firms trading below book right now - the reason being that as the assets held by these firms generate less cash/profit, the marketplaces values their assets less. If these firms were to become bankrupt, the liquidation value of the assets on their book would also fall substantially, regardless of what their ledgers say.


On Feb 27 11:20 AM moneygardener wrote:

> Gino I think you are oversimplifying. Price to book is not simply
> a reflection of financial wherewithall (free cash flow etc.). The
> ratio also reflects the earning power of assets that contribute to
> book. A tech firm will always have a higher price to book than a
> resource firm, regardless of their balance sheet.

Feb 27 01:34 PM

[Ricard:]

Good question. That's another reason not to take p/b at 'face value'. Most professional reports would annotate 'price to tangible book value' as a more accurate gauge of the company's assets on hand. Read 'Security Analysis' by Benjamin Graham. Intangibles, among other things, are more or less worthless, and are recorded because they represent what the company overpaid for otherwise valuable assets.


On Feb 27 01:08 PM GCherer wrote:

> Just a rookie here, but does book value include 'goodwill'? If so,
> should a company liquidate, is there any 'goodwill' asset to distribute?
> E.G., Micro$oft has a jubongous amount of 'goodwill' on its books.
> How does it figure in the Price to Book computation?

Feb 27 01:37 PM

[Ricard:]

Moneygardener,

After reviewing your profile, I will hold back any harsh criticism. I wholeheartedly recommend that you either take some more advanced accounting courses, or read 'Security Analysis' by Ben Graham. I am also not a finance professional, so it took me upward of four months to finish that book...but when I did, the difference in perspective was substantial.

It shocks me how many bourgeois professionals have not even the slightest clue on financial matters. I've seen MDs and PhDs squander millions on absolutely boneheaded deals that would make one question their skills on their actual profession. I attribute this to either a large amount of hubris, in that they think their advanced degree automatically translates to a proficiency in financial matters, or a large amount of gullibility, in that they believe whatever they hear in cocktail parties.

In that spirit, I applaud your efforts to learn more about finance, and wish you luck in your endeavor.

Feb 27 01:45 PM

[Josh B Thom...:]

The comments about your over simplifying do not consider you are writing an article not a book. You did quickly described the situation. Considering you were only touching on the subject, everything you said is beyond comments of over simplifying. Though veiled, the over simplifying comments condescending tone was unproductive. I do suppose veiled communication is the nature of commenting on web articles.

Feb 28 01:22 PM

[Ricard:]

One more comment -

Cash-generation is MUCH more important that simple earning power. Look at CCI or AMT from 2003-2006, or Buffett's recent purchase of Nalco, and this point becomes self-evident.


On Feb 27 11:20 AM moneygardener wrote:

> Gino I think you are oversimplifying. Price to book is not simply
> a reflection of financial wherewithall (free cash flow etc.). The
> ratio also reflects the earning power of assets that contribute to
> book. A tech firm will always have a higher price to book than a
> resource firm, regardless of their balance sheet.

Mar 01 12:15 PM

[Josh B Thom...:]

>> Cash-generation is MUCH more important than simple earnings power.

...What?
what is simple or complex about earnings power? What is earnings "power"? You have garbled many concepts to the effect of listening to 4 people talk at the same time.

Mar 02 03:06 AM

[Ricard:]

I don't think there is anything confusing about what I've stated, but let me define the terms I am using if they are becoming unclear:

To answer your question, 'earning power' in this case would be the 'bottom line', net earnings. The 'power' in the bottom line is demonstrated through the P/E ratio, which takes this figure and divides the market price of the stock by the per-share value of this net-earnings line.

However, this line, net-earnings, while important, is only one of many metrics used to gauge the value of stocks. Furthermore, net-earnings, especially when compared to free cash flow (which is much better at gauging a company's health), does not convey the full picture. In this sense, net-earnings, or the 'earning power' reflected through the P/E ratio, is simplistic, and not necessarily a fully-reliable indicator if one wants to gauge a stock's performance.

One more thing - 'earnings' have a way of being subject to vast amounts of manipulation, due to the perceived importance of the 'bottom line' to investors. Deferred taxes, massive goodwill write-downs in bad times to set up sunny skies ahead through future 'massive' earnings 'growth', financing your customers to buy your excess inventory (a la Lucent before the dot-com bust) - all of these methods have a way of spiking the earnings number, but do nothing for cash, and cash is king. Cash is what will determine whether or not your company will need to file for bankruptcy, or in Lucent's case, beg for a merger. I haven't even gone into pro-forma earning reports.

I hope this clarifies my statement:

"Cash-generation is MUCH more important that simple earning power."



On Mar 02 03:06 AM Josh B Thompson wrote:

> >> Cash-generation is MUCH more important than simple earnings power.
>
>
> ...What?
> what is simple or complex about earnings power? What is earnings
> "power"? You have garbled many concepts to the effect of listening
> to 4 people talk at the same time.

Mar 04 11:56 AM

[zagrebzagreb:]

Good Lord, there is no single 'right' way to value a company or even determine its book value. Just consider the ad hoc 'accelerated' depreciation curves applied to tech companies PP&E vs. manufacturing companies 'straight-line' depriciation of PP&E.

Mar 16 02:00 PM