Value Investing / Main Index / previous / next

July, 2004

THE SIMPLICITY OF PRICE TO BOOK VALUE INVESTING
by LARRY

Benjamin Graham has said that in the short run the stock market is a voting machine, but in the long run it is a weighing machine. In other words, short-term stock price fluctuations occur based on any number of popular concerns, often having little to do with the true worth of the underlying businesses whose shares are being traded, but, sooner or later, almost inevitably the actual intrinsic value of the company becomes reflected in its share price.

The investor can take advantage of this by purchasing stock when the shares have been bid below what they reasonably should fetch in a fair trade and selling them only once they are at or above a rational price.

One way to do this, for many companies, is to buy and sell based on the corporations' price to book value ratio. Book value means: "The value of the company if all liabilities were subtracted from assets and common stock equity." (Source: About.com, "Investing for Beginners")



By dividing a company's total book value by its number of shares, the per share book value is obtained. This figure is readily available online for thousands of companies through any number of services.

Over the long-term, the average per share price to book value averages around 2. (Currently it is about 3, indicating the market is overvalued.)

But there are companies available whose stock is selling for significantly less than a P/BK of 2. Everything else being equal, when one purchases stocks with lower than average (below 2) price to book value, he or she increases the odds of profitable equity returns for the resulting portfolio.



An easy P/BK strategy would be to buy a dozen (or so) stocks with a combined price to book value ratio of 1 or below and sell them once their P/BK averaged 2 (the long-term market average P/BK). One would thus have a relatively safe investment and obtain a 100% or greater profit (not counting dividends or commissions). For good companies, the book value will go up while one holds the stock, so the total profit of a later sale would involve dividends, improving book value, and a more rational price in relation to book value.


I like the P/BK method of quickly valuing shares of stock. It is much less subject to manipulation than the more popular price to earnings ratio. And it does not suffer the too common fate of stock dividend methods of evaluating a share's worth, that the dividend can be cut or eliminated just a little after its relative generosity has made the stock seem so tempting a buy.

Even if one does not restrict more than a portion of one's overall stock holdings (25%, for instance) to low price to book assets, a reduction in the average portfolio price to book value will tend to decrease the risk of nest egg loss and to increase the potential for superior total returns.

Since some investment strategies definitely do not lend themselves to a low price to book value approach, one might balance other methods with this technique for a significant fraction of the total assets and so gain some benefit.

A portfolio of the lowest P/BK stocks tends, not surprisingly, to be more profitable, averaging in the past, about 15% per year, compared with 10-11% for the stock market as a whole.



Another simple P/BK strategy with this kind of long-term performance in the past (no guarantee for the future) is to:

  1. Buy stocks with price to book value of .66 or below that also have a low level of debt (i.e. debt to equity [or D/E] .33 or below); and

  2. Sell them when
    1. P/BK is 1 or above; or
    2. The dividend (if any) has been cut or suspended; or
    3. The share price has gone up 50% or more; or
    4. After two years from purchase (whichever first).


For those wishing to give low price to book value investing a try, here are a few low P/BK stocks one might consider at this time (data effective with the close of business 7/13/04):

CompanySymbolRecent
Price
P/BKD/E
Industrias Bachoco SA de CVIBA$10.080.570.02
AO TatneftTNT$25.050.520.26
Isramco, Inc.ISRL$6.390.540.24
Curative Health Services, Inc.CURE$6.980.610.05
Duckwall-ALCO Stores, Inc.DUCK$16.560.650.16


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