For companies like Microsoft and Accenture, book value won't help you figure out the intrinsic value of the company. Their assets are knowledge based. But are there some companies out there where book value is an appropriate measure for intrinsic value?
Consider land developers. They acquire land for the purpose of development, and for the most part try to sell those developments as soon as they can. I would argue that book value is a pretty decent approximation of the intrinsic value of those companies. Sure, it's not perfect. In some cases, land could have been purchased years ago, and is therefore underestimated at strictly book value. So you still have to dig into the financial statements of the company to figure out what the properties are worth, but as a screening tool, looking for a low P/B ratio can be useful.
Here's the price to book ratio since 1985 for several large US homebuilders (Centex, Hovnanian, Lennar, Toll, DR Horton, Beazer):
A couple of interesting things going on here. We do see some irrational exuberance at times, where companies are trading for 3 or more times book value, but they come crashing back down when times aren't so great. In the 1980s we may be seeing the high inflationary times drive up the appetite for hard assets such as real-estate. In the early 2000s we see the runup in valuations of pretty much every builder.We can also see times when it looks like these stocks are great bargains. During the 1991 recession, they're all trading below book value, and in many cases with large margins of safety!
Today, we see these stocks trading near the bottom of their P/B range. Could this be a buying opportunity? This chart clearly shows there currently aren't huge expectations built into these stocks. But there could still be more writedowns to come, which would reduce book value. Therefore, you'll want to look for a healthy margin of safety before jumping in.
Also consider that these are the largest, most famous US homebuilders. Smaller builders may have less analyst coverage and so may represent bigger bargains!
Also consider that these are the largest, most famous US homebuilders. Smaller builders may have less analyst coverage and so may represent bigger bargains!
2 comments:
Saj, nice post as always. I just came across this doing some research on the builders. I'm curious where you came across the historical P/B ratios of the homebuilders? I've also been spending time thinking about the economics of the business, and I find it hard to understand why these companies should trade much more than book. I know they more often than not do trade at premiums, sometimes significant premiums to book, but other than when land is really understated (which doesn't seem to be the case since most of them cycle through their inventory relatively quickly), I'm not sure why these companies would ever be worth more than book. It seems to me that they are in a never ending cycle between using up cash to build inventory during good times (when cash flow is low or negative and supported by additional borrowings) and then at some point they finally make cash flow by selling down inventory. Often the cash has to be used to pay back debt, but then they are back to square one and have to start over, since they need inventory to sell. I guess I'm surprised at how often they trade at substantial premiums to their book values, and how volatile their valuations are...
Hi John,
This was a long time ago! I think I probably used Yahoo price data and got the book values from financial statements.
I agree with you that book value is a good proxy for these guys, and that one probably shouldn't expect intrinsic worth to be too much higher than book value for these companies.
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