Wednesday, June 4, 2008

What's Book Value Worth?

Do people care about price to book value when they buy a stock? For a given stock on Google Finance, you won't find the price to book value shown anywhere on the page. On Yahoo's finance site, you have to scroll down the 12th page of info (titled 'Statistics') to find the P/B. It would seem P/B is not an important measure in investor's minds.

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!

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