Value Investing / Main Index / previous / next

February, 2015

A FRESH LOOK AT LOW PRICE TO BOOK
by LARRY

In the early 20th Century, there was little system to the valuing of stocks. It is perhaps not surprising that assets could often reach sky-high per share costs just based on rumors. This was all the more the case because people could buy on extreme margin, sometimes putting as little as 10% down. Once the Great Depression began, however, the mood did a 180. The market crash meant many equities were selling at supremely bargain levels. Yet few wanted to touch any of them. The good were rejected with the bad. The efforts of value investor Benjamin Graham slowly began to change this. He and David Dodd co-authored Security Analysis, the first thoroughgoing attempt to reveal order amid the chaos, to separate the then many good from the few very bad apples in common stocks.

Among his favorite criteria were companies that were profitable, going concerns having high book value in relation to price, yet without much debt. He showed how over the long-term stocks of such businesses tended to reliably outperform the market. He and his investment firm researched the best means for the average investor to pick money making stocks and finally came up with a simple standard: stocks must have an indication of real value plus one of safety. Of the diverse standards for each, he felt two that were most readily available to regular folks are low price to book value plus reasonable debt to equity.



Price to book, also referred to as price to book value or P/Bk, means the closing per share price divided by the last quarter's book value per share. Book value, in turn, refers to the total value of the company less all debts or other liabilities and less intangible value such as goodwill or patents. To get per share book value, that total book value is divided by the number of common stock shares. A low price to book value indicates that the per share book value is greater than the price. Typically, a bargain level P/Bk value is 0.8 or below. In theory, if a company had to cease operations, one could at least salvage the book value. There are many exceptions to this, however, so, assuming it remains a profit making enterprise, the lower the P/Bk the investor can find in a good company the better.

Debt to equity, also referred to as D/E, usually is regarded as the company's liabilities divided by shareholders' equity. Shareholders' equity, in turn, means the business' total assets less its total liabilities. Graham wanted D/E to be .99 or below, in other words that there be more assets per share left over after subtracting all debt.



Results will vary, but research has shown that stocks bought with P/Bk 0.8 or below plus D/E .99 or below and held till up in price 50% or more or till the P/Bk is 1.2 or above, whichever first, have average gains plus dividends of about 15% a year, a significantly better total return than is normally provided by market averages.


NameTicker
Symbol		Recent
Price		P/BKD/EDividendPayout
Ratio
EZCorp, Inc.EZPW$10.370.640.390.000.00
Gran Tierra Energy, Inc.GTE$2.610.500.000.000.00
Nabors Industries, Ltd.NBR$13.520.690.721.70%15.00%
TransGlobe Energy Corp.TGA$3.030.420.156.40%23.00%
Ternium, S.A.TX$18.730.670.334.10%29.00%


In my own experience, low price to book stocks that also have some earnings and, if there is a dividend, a payout ratio (the ratio of dividend payout to earnings) of 0.6 or below, tend to do better and have less downside risk in a correction or bear market.

No guarantees, but at the table, there are five low price to book value stocks that appear in my view to currently offer good value without great risk.

One can look online for studies on when is the best time to sell a stock bought with low price to book value. Some prefer to sell after a year, others after two years, still others after five, or some would have us sell only after the price to book value has risen to 1.0 or to 1.2 or above, etc.



The general rule that works for me is to acquire a portfolio of maybe 25-30 such stocks and then gradually sell off from the portfolio those with the then worst current price to value and debt to equity, replacing them with new stocks offering the best value and safety one can find. Once the initial portfolio has been obtained, by adding, say, one or two bargain stocks a month, one can then gradually "harvest" one or two a month, using the proceeds to buy new assets to replace them.

If one has a certain penchant for numbers and details, this process can be both enjoyable and financially rewarding. Though total returns of 15-20% a year are common with low price to book value investing, this approach is not without risk. Inevitably there will be some such individual investments that do not pan out. Their sales can help offset the taxes on those that do.

If after studying various methods one picks this value investing technique, an investor's first step might be to carefully select a few stocks in which to acquire shares, maybe one or two of the above, following that set of purchases with a like number and amount the next month, and so on. Happy and lucrative investing!



DISCLAIMER

Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)



Value Investing / Main Index / previous / next