Lately we’ve been talking a lot here at the Daily Angle about book value, and for good reason; with the economy down like it is, investors have a (potentially) once-in-a-lifetime opportunity to buy some high quality stocks at bargain prices. One of the metrics value investors have long used for finding undervalued stocks is the price to book ratio.
Conventional wisdom states that a company trading below book value (i.e. a price to book below 1 ) is generally a sign of a bargain stock. However, depending on the source of your information (that is to say, the financial portal from which you are doing your stock screens) the price to book value that you are heeding may be incredibly misleading.
Despite the fact that Benjamin Graham’s monumental Security Analysis defines book value as the sum of all tangible assets, many screeners and finance portals include intangible assets and/or goodwill in their calculations of book value. So common is this practice that, to get to the heart of the matter we have decided to devise a new metric (which is actually an old metric in disguise). We’re calling it Price to Book to Price to Tangible Book to clarify the impetus for the derivation, but really that just works out to tangible book value to book value.
In otherwords, what percentage of total book value is made up by tangible assets? We ran a screen for big(ish) companies with a low (under 1) price to book, then opened up their balance sheet and calculated our own metrics to look further under the hood. (Incidentally, these numbers are coming from manual calculations using the current market cap, rather than book value per share.) Here are three interesting stocks, we found in the screen.
1. Dow Chemical Company (DOW)
Price to Book: .745
Price to Tangible Book: .970
Price to Book to Price to Tangible Book: .768
To be honest, I was expecting the P/B/P/TB to come out much lower for a company like Dow, whose products have tremendous brand recognition (did you know that styrofoam is a proprietary brand?). I would expect that sort of thing to rack up the intangible assets and goodwill points, but interestingly, it does not. Still, while the difference between a price to book of .734 and a price to tangible book right around 1 is a testament to the strength of DOW’s intangibles (e.g. their brands) a price to tangible book under 1 may be an indication of an overly deflated stock price.
Price to Book: .643
Price to Tangible Book: .971
Price to Book to Price to Tangible Book: .662
The balance sheet lists no intangible assets, but a fair amount of goodwill drags the company’s P/B/P/TB somewhat lower than I expected for a company that does nothing but create industrial grade aluminum. While a price to tangible book below 1 is nothing to scoff at, the value here is not nearly as stark as it initially appears upon first glance at the simple price to book.
Price to Book: .604
Price to Tangible Book: .663
Price to Book to Price to Tangible Book: .911
Pioneer Natural Resources is a major oil and natural gas drilling company. The P/B/P/TB is an intriguingly high .911, something I wouldn’t have expected even from an oil company. A quick run down their balance sheet indicates no intangible assets whatsoever and very little change in goodwill year over year. Likely, the deflated price can be pegged directly to the financial crisis of October and the resulting plummeting oil prices. That said, the company also has a suspiciously low current ratio (.842) that raises a red flag for a business of this size. If and when oil prices rebound, expect Pioneer to bounce back with them.