Ever wonder how analysts determine if a stock is ‘on sale’ or undervalued? One metric historically used by Value investors throughout history is Price-to-Book Value per share. This ratio (also denoted P/B) is a comparison of a company’s share price versus by its Net Worth divided by its common shares outstanding.
Price to Book
In accounting terms, net worth is derived by subtracting an individual or company’s Liabilities (borrowings or future financial obligations) from its Assets (like real estate, inventory or financial investments). A P/B of less than one would mean the company’s stock price is less than its net worth or book value per share.
This method was popularized by Benjamin Graham in the early part of the 20th century as a plethora of company’s stocks traded for less than their net worth following the Great Depression. In a period of economic distress, paying less for a company than its ascertainable accounting value (gleaned from analyzing its financial records) was thought to offer a margin of error with upside for investors.
The metric isn’t a silver bullet and there are some things to consider when putting it into practice. For starters, while Value investors would prefer a lower price-to-book multiple than a higher one, it usually reflects market pessimism about the company’s future prospects.
But as can often happen, the pendulum between pessimism and euphoria can swing too far in either direction. Take General Motors (GM) for example, which trades for a P/B ratio of .76. While GM doesn’t necessarily boast the allure or flashiness of some electric vehicle makers, the company remains quite profitable and is making solid strides to develop its own line of EV products.
Uncovering Bargains
A company’s book value also doesn’t always properly account for intellectual property or brand value, which can be significant for some companies.
But even some physical assets like real estate can also have one value “on the books” and another in the marketplace. These types of discrepancies could be fruitful ground for investors. Take real estate for example, which is recorded at its initial purchase value in a company’s financial statements, but only marginally adjusted over time as properties are improved. That means the general appreciation in the value of a company’s real estate may go unnoticed by the casual onlooker.
The real estate portfolios of retailers like Nordstrom (JWN) and Kohl’s (KSS) have gotten particular interest in recent years from certain investors for this reason. Their thinking is value might be unlocked by taking strategic action to monetize the real estate, even as their core retailing businesses have hit a lull.
Conclusion
Finally, note that companies in certain industries or sectors might rarely trade near or below their per share book values. So,it may be reasonable to compare companies within the same sector.
The examples listed aren’t an exhaustive list of reasons to incorporate Price-to-Book value in your stock investing, but we think there is plenty of support when used appropriately to consider this age-old strategy.
Kovitz Investment Group Partners, LLC (“Kovitz”) is an investment adviser registered with the Securities and Exchange Commission. This report should only be considered as a tool in any investment decision and should not be used by itself to make investment decisions. Opinions expressed are only our current opinions or our opinions on the posting date. Any graphs, data, or information in this publication are considered reliably sourced, but no representation is made that it is accurate or complete and should not be relied upon as such. This information is subject to change without notice at any time, based on market and other conditions. Past performance is not indicative of future results, which may vary.