This month we focus on companies with large asset value residing on their balance sheets. We profile and analyze twenty stocks trading at a discount to tangible book value. While some of the equities also trade at a discount to net current asset value, i.e., qualify as Ben Graham “net nets,” most of the ideas assume a going-concern valuation scenario rather than a liquidation scenario. Above all, we look for firms with understated balance sheet values as well as significant earning power.
Economists Eugene Fama and Kenneth French have extensively studied the relationship between stock performance and book-to-market ratios. Their seminal paper covered the period from 1963-1990 and included nearly all stocks on the NYSE, Amex and Nasdaq stock markets. The stocks were divided into ten groups (deciles) based on book-to-market and were re-ranked annually. The highest book-to-market stocks outperformed the lowest book-to-market stocks by 21% to 8%, on average, with each descending decile performing worse than the previous. Fama and French also examined the beta of each decile and found that value stocks had lower risk, while growth stocks had the highest risk. The study had a profound impact in part because Fama was a long-time champion of the capital asset pricing model.
Several well-known value investors achieved strong investment returns during their careers by following a strategy that involved buying stocks trading at a discount to their readily ascertainable asset values. Ben Graham, Walter Schloss, John Neff and Marty Whitman are just a few names that come to mind. Of course, we note that many of the most successful investors, including Warren Buffett and Joel Greenblatt, have migrated away from balance sheet values toward “good” businesses over time, producing even more impressive returns.
A “holy grail” of value investing might be uncovering opportunities that provide both asset protection on the balance sheet and own businesses with high returns on capital. This combination is virtually impossible to find unless a company has experienced a steep near-term profit decline. In such an instance, a firm may appear to be a low-return business when in fact normalized profitability implies attractive returns on capital. Another potential “holy grail” are companies whose balance sheet assets are partly non-core, i.e., not actually employed in the operating business.
The Manual of Ideas, August 1, 2011 [view excerpt]
— Underappreciated Balance Sheet Values (117 pages)
Editorial Commentary — John Mihaljevic highlights three investment ideas
Superinvestor Update — Tracking the portfolio moves of top investors
Exclusive Interview with Mike Pruitt, Matt Miller and Joe Koster
Exclusive Interview with Paul Johnson — On selecting value investments
Screening for Underappreciated Asset Values — Balance sheet bargains
20+ Investment Candidates — Companies with strong asset value
Favorite Value Screens — Screen results for bargain-hunting investors
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