The book value of a company’s equity is remarkable not just because it has been a predictive indicator of stock performance over the past 80 years, but also because economists actually agree on the usefulness of the price-to-book (P/B) ratio. Any majority agreement among economists is truly remarkable in light of their dissention: it is said that if all economists were laid end to end, they would never reach a conclusion. Past stock performance has shown that generally, over long periods of time, stocks with lower P/B ratios outperform stocks with higher P/B ratios.
Using the P/B ratio to gauge a stock is useful in many situations. Unlike the P/E ratio, the P/B ratio is effective if a firm has negative or anomalous earnings. Moreover, earnings are volatile and are sometimes gamed by management, which casts doubt on many versions of the P/E ratio. However, the P/B ratio fails to account for internally-developed intellectual property including patents, brands, and trademarks.
Using the P/B ratio as a measure of value, here are five P/B bargains:
Bunge Limited (BG) is a large cap with a P/B ratio of 0.89 that processes foodstuffs in dozens of countries. Its operations are profitable and are cheaply priced at a P/E multiple of 4.60 and a P/S multiple of 0.23 (ttm). Bunge is even cheaper than its attractively priced competitor, Archer-Daniels-Midland Company (ADM), which has higher multiples. ADM trades at a P/B multiple of 1.22, a P/E multiple of 9.73 (ttm), and a P/S multiple of 0.28 (ttm).
Bunge is a compelling P/B bargain because there is little risk that the firm’s assets are overstated. Bunge’s largest long-term asset is property, plant, and equipment (PP&E), which is to be expected since the company processes raw agricultural products through mills, presses, and other machines to produce value-added products like soybean oil or flour. Accounting conventions state the book value of the firm’s machinery at cost less depreciation, and it is likely below market value or replacement value. Given the rise in commodity prices, it is unlikely that building new plants would cost so little. The safety of these conservative estimates is refreshing in a world where company balance sheets often contain imagined values for deadbeat mortgage loans and unrealizable tax assets. It is remarkable that investors can purchase the net assets of Bunge for 89% of these conservative estimates.
Another profitable company with tangible assets with equity trading at a P/B discount is Nippon Telegraph & Telephone Corp. (NTT). This company is cheap with a P/B ratio of 0.65, a P/E ratio of 10.11 (ttm), and a P/S 0.50 (ttm). Like many Japanese stocks, NTT has a lower P/B ratio than its counterparts in the United States. When compared with NTT, AT&T (T) has a higher P/B ratio of 1.57. NTT’s assets are less inflated by acquisition premiums: goodwill makes up 27.8% of AT&T’s assets, but only comprises 3.8% of NTT’s assets.
Investors should appreciate that a P/B bargain like NTT is rare. A huge 35% discount to the book value of net assets is usually found in companies in ravaged industries that suffered losses for consecutive years. Instead NTT is a profitable company in a stable industry. Regardless of Tsunamis, meltdowns, and an aging population, the Japanese will continue to use phone services. This firm is so secure that it seems like only an apocalyptic disaster from science fiction could bankrupt it.
On the other hand, B+H Ocean Carriers Ltd. (BHO) is an example of low P/B ratio firm in a terrible industry. BHO ships ore, dry freight, and oil across oceans. Foolishly, shipbuilders filled the oceans with ships before the economic downturn with the expectation of endless economic prosperity and trade growth. The oversupply in shipping makes the housing bubble mild by comparison. During the recession, the Baltic Dry Index, an average of dry bulk shipping rates, dropped more than 95%. Charter prices have since recovered slightly, but are expected to deteriorate as shipbuilders are slated to add an additional 40% shipping capacity to the world’s fleets over the next two years.
Despite the horrible industry outlook, BHO is an attractive way to weather the economic storm. BHO is cheap, trading at a P/B ratio of 0.40, a P/E ratio of 4.56, and a P/S ratio of 0.59 (ttm). Profitability given the circumstances is unusual, but understandable given BHO’s unusual fleet. BHO’s ships are flexible and can be used to ship ore, dry freight, or oil. In contrast, most ships are designed to carry one of those cargos. This flexibility allows BHO to serve the highest bidder on every leg of a voyage, rather than having to accept lower prices for a return voyage.
Strangely, even greater P/B discounts can be found in the tech sector. SigmaTron International Inc. (SGMA) trades at a P/B multiple of 0.38, a P/E multiple of 9.61, and a P/S multiple of 0.13 (ttm). This micro-cap company makes circuit boards for appliances and electronics and has been profitable for the past 10 years with the exception of 2008. One reasonable source of a discount to book value would be the firm’s low $19 million market capitalization. Since the firm’s shares have a smaller market and are less liquid than larger companies, SGMA’s investors must pay a larger bid-ask spread to trade the shares than they would for other stocks. Though the spread is currently about 5 cents, or about 1% of the share price, it could easily widen. This is a penalty for traders who aim to flip the stock. Moreover, firms with low capitalizations and thin trading frequently become illiquid or delist altogether. In short, potential SGMA investors should be prepared for the long haul. Thus, SGMA’s cheap valuations are attractive to long-term investors looking for value without having to brave disasters.
Low P/B ratios in other tech companies like Hutchinson Technology Inc. (HTCH) are consistent with past losses. HTCH produces precision assembly magnet assemblies for disc drives and medical applications. The firm’s last positive earnings were realized in the 2007 fiscal year. Despite more recent paper losses, Hutchinson has generated positive operating cash flows and mixed total cash flows over the last four years. Today, Hutchinson has a current ratio of 4.5, reflecting ample capacity to pay bills in the coming year. In light of these financial metrics and recently announced cost-saving restructuring initiatives, liquidity does not seem to be an issue. Clearly the firm is likely to survive for years to come.
Since Hutchinson is not likely to go bankrupt, HTCH stock is a compelling way to buy technology assets on the cheap. The firm is clearly solvent, with a D/E ratio of 0.65. This firm is an extreme value play with a P/B ratio of 0.33, allowing investors to invest in the firm’s net assets at 1/3 of their accounting value. Investing in HTCH is a bet that the company will either become profitable in the long term or will be acquired by a buyer at a price that is closer to its book value.