Showing posts with label Book value. Show all posts
Showing posts with label Book value. Show all posts

Sunday 14 May 2023

Warren Buffett: Earnings and not book value are what determine the value of a business.

 

 


@5.45  

Earnings are what determine value and not book value.  Book value is not a factor we consider.  Future earnings are a factor we consider.  

Earnings have been poor for many great Japanese companies.  If you think the return on equity of the Japanese companies is going to increase dramatically, then you are going to make a lot of money in Japanese stocks.  But the returns on equity of Japanese businesses have been quite low, and that makes a  low price to book ratio very appropriate because earnings are measured against books.  

A company earning 5% on book value, I do not want to buy it at book value, if I think it is going to keep earning 5% on book value.     A low price to book ratio means nothing to us.  It does not intrigue us.  In fact, if anything, we are less likely to look at something that sells at a lower value in relation to book than something that sells at a higher relation to book.  The chances are we are looking at a poor business in the first case and a good business in the second case.





Wednesday 4 March 2020

Warren Buffett Explains Why Book Value Is No Longer Relevant



The Oracle of Omaha on why cash flows are more important than book value
March 03, 2020


For decades, value investors have used book value per share as a tool to assess a stock's value potential.

This approach began with Benjamin Graham. Widely considered to be the father of value investing, Graham taught his students that any stocks trading below book value were attractive investments because the companies offered a wide margin of safety and low level of risk. To this day, many value investors rely on book value as a shortcut for calculating value.



Buffett on book value

Warren Buffett (Trades, Portfolio) is perhaps Graham's best-known student. For years, Buffett used book value, among other measures, to asses a business's net worth. He also used book value growth as a yardstick for calculating Berkshire Hathaway's (NYSE:BRK.A) (NYSE:BRK.B) value creation.

However, as far back as 2000, the Oracle of Omaha started to move away from book value. He explained why at the 2000 annual meeting of Berkshire shareholders. Responding to a shareholder who asked him for his thoughts on using book value to track changes in intrinsic value, Buffett replied:

"The very best businesses, the really wonderful businesses, require no book value. They — and we are — we want to buy businesses, really, that will deliver more and more cash and not need to retain cash, which is what builds up book value over time...

In our case, when we started with Berkshire, intrinsic value was below book value. Our company was not worth book value in early 1965. You could not have sold the assets for that price that they were carried on the books, you could not have — no one could make a calculation, in terms of future cash flows that would indicate that those assets were worth their carrying value. Now it is true that our businesses are worth a great deal more than book value. And that's occurred gradually over time. So obviously, there are a number of years when our intrinsic value grew greater than our book value to get where we are today...

Whether it's The Washington Post or Coca-Cola or Gillette. It's a factor we ignore. We do look at what a company is able to earn on invested assets and what it can earn on incremental invested assets. But the book value, we do not give a thought to."

It is no secret that value as an investing style has underperformed growth over the past decade. There's no obvious explanation as to why this is the case, but one of the explanations could be that the definition of value is out of date. Buffett's comments from the 2000 annual meeting seem to support this conclusion.



No longer a good measure

Book value was an excellent proxy for value when companies relied on large asset bases to produce profits. As the economy has shifted away from asset-intensive businesses and more towards knowledge-intensive companies, book value has become less and less relevant.

What's more, as Buffett explained in 2000, book value does not necessarily represent intrinsic value. Just because a stock is trading below its book value does not necessarily mean it is worth said book value.

The same is true of companies trading at a premium to book. The intrinsic value of that business could be significantly higher than book value as book value does not tend to reflect intangible assets.

Investing is an art, not a science, and valuing businesses is not a straightforward process. Investors cannot rely on a simple metric or shortcut to assess value. Many factors contribute to intrinsic value and intrinsic value growth, and using book value as a proxy for intrinsic value is an outdated method. Even in Graham's time, it wasn't always correct.


https://www.gurufocus.com/news/1063604/warren-buffett-explains-why-book-value-is-no-longer-relevant


Sunday 12 January 2020

Conventional Valuation Yardsticks: Book Value

Book Value

What something cost in the past is not necessarily a good measure of its value today.  Book value is the historical accounting of shareholders' equity, the residual after liabilities are subtracted from assets.

Sometimes historical book value (carrying value) provides an accurate measure of current value, but often it is way off the mark.
  • Current assets, such as receivables and inventories, for example, are usually worth close to carrying value, although certain types of inventory are subject to rapid obsolescence. 
  • Plant and equipment, however, may be outmoded or obsolete and therefore worth considerably less than carrying value. 
  • Alternatively, a company with fully depreciated plant and equipment or a history of write-offs may have carrying value considerably below real economic value. 
  • Inflation, technological change, and regulation, among other factors, can affect the value of assets in ways that historical cost accounting cannot capture. 
  • Real estate purchased decades ago, for example, and carried on a company's books at historical cost may be worth considerably more. 
  • The cost of building a new oil refinery today may be made prohibitively expensive by environmental legislation, endowing older facilities with a scarcity value. 
  • Aging integrated steel facilities, by contrast, may be technologically outmoded compared with newly built mini-mills. As a result, their book value may be significantly overstated. 


Reported book value can also be affected by management actions.
  • Write-offs of money-losing operations are somewhat arbitrary yet can have a large impact on reported book value. 
  • Share issuance and repurchases can also affect book value. 
  • Many companies in the 1980s, for example, performed recapitalizations, whereby money was borrowed and distributed to shareholders as an extraordinary dividend. This served to greatly reduce the book value of these companies, sometimes below zero. 
  • Even the choice of accounting method for mergers-purchase or pooling of interests - can affect reported book value.


To be useful, an analytical tool must be consistent in its valuations. Yet, as a result of accounting rules and discretionary management actions, two companies with identical tangible assets and liabilities could have very different reported book values.
  • This renders book value not terribly useful as a valuation yardstick. 

As with earnings, book value provides limited information to investors and should only be considered as one component of a more thorough and complete analysis.




Conventional Valuation Yardsticks: Earnings, Book Value, and Dividend Yield

Both earnings and book value have a place in securities analysis but must be used with caution and as part of a more comprehensive valuation effort.

Saturday 29 April 2017

Primary aim of management is to increase the book value and the market value of the company.

The primary aim of management is to increase

  • the book value and 
  • market value of the company.



Book Value

Book value (shareholders' equity on the company's balance sheet) is calculated as total assets less total liabilities.

It reflects the historical operating and financing decisions made by the company.

Management can directly influence book value (e.g., by retaining net income).


Market Value

However, management can only indirectly influence a company's market value.

Market value of a company is primarily determined by investors' expectations about the about, timing and uncertainty of the company's future cash flows

A company may increase its book value by retaining net income, but it will only have a positive effect on the company's market value if investors expect the company to invest its retained earnings in profitable growth opportunities.

If investors believe that the company has a significant number of cash flow generating investment opportunities coming through, the market value of the company's equity will exceed its book value.



Price to book ratio (market to book ratio)

A useful ratio to evaluate investor's expectations about a company is the price to book ratio.

If a company has a price to book ratio that is greater than industry average, it suggests that investors believe that the company has more significant future growth opportunities than its industry peers.

It may not be appropriate to compare price to book ratios of companies in different industries because the ratio also reflects investors' growth outlook for the industry itself.


Accounting Return on Equity

An important measure used by investors to evaluate the effectiveness of management in increasing the company's book value is accounting return on equity.




Thursday 20 December 2012

Warren Buffett: Book Value and Intrinsic Value


Book Value and Intrinsic Value


     We regularly report our per-share book value, an easily calculable number, though one of limited use.  Just as regularly, we tell you that what counts is intrinsic value, a number that is impossible to pinpoint but essential to estimate.

     For example, in 1964, we could state with certitude that Berkshire's per-share book value was $19.46.  However, that figure considerably overstated the stock's intrinsic value since all of the company's resources were tied up in a sub-profitable textile business.  Our textile assets had neither going-concern nor liquidation values equal to their carrying values.  In 1964, then, anyone inquiring into the soundness of Berkshire's balance sheet might well have deserved the answer once offered up by a Hollywood mogul of dubious reputation:  "Don't worry, the liabilities are solid."

     Today, Berkshire's situation has reversed: Many of the businesses we control are worth far more than their carrying value.  (Those we don't control, such as Coca-Cola or Gillette, are carried at current market values.)  We continue to give you book value figures, however, because they serve as a rough,  understated, tracking measure for Berkshire's intrinsic value. 

     We define intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life.  Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move.  Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.

     To see how historical input (book value) and future output (intrinsic value) can diverge, let's look at another form of investment, a college education.  Think of the education's cost as its "book value."  If it is to be accurate, the cost should include the earnings that were foregone by the student because he chose college rather than a job.

     For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value.  First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education.  That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day.  The dollar result equals the intrinsic economic value of the education.

      Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn't get his money's worth.  In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed.  In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.

     Now let's get look at Scott Fetzer, an example from Berkshire's own experience.  This account will not only illustrate how the relationship of book value and intrinsic value can change but also will provide an accounting lesson.  Naturally, I've chosen here to talk about an acquisition that has turned out to  be a huge winner.

    The reasons for Ralph's success are not complicated.  Ben Graham taught me 45 years ago that in investing it is not necessary to do extraordinary things to get extraordinary results.  In later life, I have been surprised to find that this statement holds true in business management as well.  What a  manager must do is handle the basics well and not get diverted.  That's precisely Ralph's formula.  He establishes the right goals and never forgets what he set out to do.  On the personal side, Ralph is a joy to work with.  He's forthright about problems and is self-confident without being self-important.   He is also experienced.  Though I don't know Ralph's age, I do know that, like many of our managers, he is over 65.  At Berkshire, we look to performance, not to the calendar.  Charlie and I now keep George Foreman's picture on our desks.  You can make book that our scorn for a mandatory retirement age will grow stronger every year.

Sunday 26 February 2012

Warren Buffett on Economic Goodwill (Intangible asset)


WARREN BUFFETT ON ECONOMIC GOODWILL

This is what Warren Buffett calls economic good will which he explained in 1983 like this:
‘[B]usinesses logically are worth far more than net tangible assets when they can be expected to produce earnings on such assets considerably in excess of market rates of return.’

Using by analogy, one of the favorite examples of Warren Buffett, take two separate companies. Company A has a net worth of $100,000, $40,000 of which is net tangible assets and $60,000 of which is intangible (brand name, goodwill, patents etc). Company B has the same net worth but $90,000 its assets are tangible. Each company earns $10,000 a year.
  • So Company A is earning $10,000 from tangible assets of $40,000 and Company B is earning $10,000 from tangible assets of $90,000.
If both companies wanted to double earnings, they might have to double their investment in tangible assets. 
  • For Company A to do this, it would have to spend $40,000 to add $10,000 of earnings. 
  • For Company B to do this, it would have to spend another $90,000 to add $10,000 to earnings. 
All other things being equal, Company A would have better future prospects of increase in real earnings than Company B.

THE REAL PROFITABILITY OF A COMPANY

For these reasons, Warren Buffett has said that, in calculating the real profitability of a company, there should be no amortisation of economic goodwill. Does the Gillette brand name actually decrease in value each year? Of course not.

The thoughts of both Graham and Warren Buffett are worth consideration. Book value is another ingredient in the investment equation.

Benjamin Graham and Warren Buffett appear to have differences in importance on tangible and intangible assets.

The assets of a company can be either tangible or intangible and, on this point, Benjamin Graham and Warren Buffett appear to have differences in importance.


WHAT BENJAMIN GRAHAM SAID ABOUT INTANGIBLE ASSETS

‘Earnings based on these intangibles [eg goodwill] may be even less vulnerable to competition than those which require only a cash investment in productive facilities.

'Furthermore, when conditions are favorable, the enterprise with the relatively small capital investment is likely to show a more rapid rate of growth.

Ordinarily it can expand its sales and profits at slight expense and therefore more rapidly and profitably for its stockholders than a business requiring a large plant investment per dollar of sales.’ Emphasis added.


HOW WARREN BUFFETT LOOKS AT INTANGIBLE ASSETS

This last comment of Graham has importance for Warren Buffett, who seems to really like companies with valuable, and sometimes irreplaceable, goodwill. 

To Warren Buffett, it is this intangible good will, an asset that continually produces profits without the need to spend money on maintenance, upgrading or replacement, that adds value to a company. 

Consider what it is that is most important in producing profits for Coca Cola: its name and recipe, or the various factories that produce the drink.

THE BENJAMIN GRAHAM APPROACH TO BOOK VALUE



Graham clearly considered book value an important factor in assessing share investment. He did not include intangibles in his calculations of book value and was attracted towards companies that sold at below their book value. 

This was a big factor in making a judgment about the company as an investment. He said this:
‘It is an almost unbelievable fact that Wall Street never asks, "How much is the business selling for?". Yet this should be the first question in considering a stock purchase.
'If a business man were offered a 5% interest in some concern for $10,000, his first mental process would be to multiply the asked price by 20 and thus establish a proposed value of $200,000 for the entire undertaking. The rest of his calculation would turn about whether the business was a "good buy" at $200,000.’

Graham did however acknowledge that under ‘modern conditions’ intangibles were just as much an asset as tangibles, assuming of course that a proper value could be determined. They could, in some situations, even be superior assets.

WHAT IS BOOK VALUE?


WHAT IS BOOK VALUE?

The book value of a company is generally considered its net worth; the book value per share would be the net worth of a company divided by the number of shares outstanding.


BENJAMIN GRAHAM DEFINITIONS

There is a need, in considering the book value of a company share, to know what certain terms mean - and who better to explain them than the doyen of investment analysis, Benjamin Graham. His definitions are:

Tangible assets: Assets either physical or financial in character eg plant, inventory, cash, receivables, investments.

Intangible assets: Assets which are neither physical nor financial in character. Include patents, trademarks, copyrights, franchises, good will, leaseholds and such deferred charges as unamortised bond discount.

Graham took the view in Security Analysis that intangible assets should not be taken into account when calculating book value; hence, in this sense, book value per share would be the same as net tangible assets per share (NTA) as opposed to net assets per share (NA).

So, the assets of a company can be either tangible or intangible and, on this point, Benjamin Graham and Warren Buffett appear to have differences in importance.


Monday 6 February 2012

Knowing and Setting the Upper Limits of Share Price

The P/E also can be used to establish a cap on intrinsic value.

While asset values set the lowest level for estimating intrinsic value, the P/E can serve as an upper limit.

The P/E ratio establishes the maximum amount an investor should pay for earnings.

  • If the investor decides that the appropriate P/E ratio for a stock is 10, the share price paid should be no more than 10 times most recent yearly earnings.


It is not wrong to pay more, Graham and Dodd noted; it is that doing so enters the realm of speculation.  
  • Since young, rapidly expanding companies generally trade at a P/E ratio of 20 to 25 or above, Graham usually avoided them, which was one reason he never invested in some new start up stocks, though he used and was impressed by their products early in his career.

Sunday 18 September 2011

Finance for Managers: Asset-Based Valuations - Equity Book Value

One way to value an enterprise is to determine the value of its assets.  Here are four approaches to asset-based valuations:

1.  Equity book value,
2.  Adjusted book value,
3.  Liquidation value, and,
4.  Replacement value.


Equity Book Value

Equity book value is the simplest valuation approach and uses the balance sheet as its primary source of information.  Here's the formula:

Equity Book Value = Total Assets - Total Liabilities

Example:  Amalgamated Hat Rack
Total assets $3,635,000
Total liabilities $1,750,000

Equity book value = Total Assets - Total Liabilities = $1,885,000

In other words, reduce the balance sheet (or book) value of the business's assets by the amount of its debts and other financial obligations, and you have its equity value.

This equity-book-value approach is easy and quick.  And it is not uncommon to hear executives in a particular industry roughly calculating their company's value in the context of equity book value.

For example, one owner might contend that his or her company is worth at least book value in a sale because that was the amount that he or she had invested in the business.   But equity book value is not a reliable guide for businesses in many industries.  The reason is that assets are placed on the balance sheet at their historical costs, which may not be their value today.  The value of balance0sheet assess may be unrealistic for other reasons as well.  Consider Amalgamated assets:

-  Accounts receivable could be suspect if many accounts are uncollectible.
-  Inventory reflects historic cost, but inventory may be worthless or less valuable than its stated balance-sheet value (or "book" value) because of spoilage or obsolescence.  Some inventory may be undervalued.
- Property, plant, and equipment net of depreciation should also be closely examined - particularly land.  If Amalgamated's property was put on the books in 1975 - and if it happens to be in the heart of Silicon Valley - then its real market value may be ten or twenty times the 1975 figure.

The preceding are just a few examples.  For many reasons, however, book value is not always true market value.

Saturday 1 January 2011

Value Investing is a time tested investment strategy that works in most market environments.

Value investing is finding a good quality stock that you are proud to own for an inexpensive or bargain price.

Basically, a value stock has a low price to book value and a low price to earnings ratio. In determining whether a stock is inexpensive or not, one needs to analyze the company’s book value, also known as shareholders’ equity. You need to determine what the true net worth of a company is by calculating a tangible book value.







It’s critical to pick a company with an excellent management team.

http://myinvestingnotes.blogspot.com/2010/07/characteristics-of-value-stocks_23.html

Sunday 4 April 2010

Buffett (1985): Energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks in a chronically leaking boat


With volatility being the order of the day, we as investors indeed need some calming influence so as to help us stay rational and make sense of the crisis that has gripped the global capital markets currently. And what better way to do this than to turn to the man who answers to the name of Warren Buffett and who arguably, is one of the world's best practitioner of the art of rationality and objective thinking.

In the following few paragraphs, let us see what the master offers by way of investment wisdom in his 1985 letter.

This letter like his previous letters touches upon a variety of topics, some covered before while others brand new. What we would like to reproduce here is the biggest and the best of them all. The year 1985 was the year when the master finally chose to shut down his textile business by liquidating all of company's assets. While going through the brief history of the business and explaining his rationale behind the sale, the master has systemically busted some of the biggest myths related to investing and shown us why one should prefer business that generate returns with as little capital employed as possible. He has also shown why reliance on book values and replacement costs while valuing a company could turn to be dangerous.

While the discourse is indeed exhaustive, we believe that every sentence is worth its weight in gold. Laid out below is an edited account of his textile business shutdown:

"In July we decided to close our textile operation, and by year end this unpleasant job was largely completed. The history of this business is instructive.

When Buffett Partnership Ltd., an investment partnership of which I was general partner, bought control of Berkshire Hathaway 21 years ago, it had an accounting net worth of US$ 22 m, all devoted to the textile business. The company's intrinsic business value, however, was considerably less because the textile assets were unable to earn returns commensurate with their accounting value. Indeed, during the previous nine years (the period in which Berkshire and Hathaway operated as a merged company) aggregate sales of US$ 530 m had produced an aggregate loss of US$ 10 m. Profits had been reported from time to time but the net effect was always one step forward, two steps back.

We felt, however, that the business would be run much better by a long-time employee whom we immediately selected to be president, Ken Chace. In this respect we were 100% correct: Ken and his recent successor, Garry Morrison, have been excellent managers, every bit the equal of managers at our more profitable businesses.

We remained in the business for reasons that I stated in the 1978 annual report (and summarized at other times also): "(1) our textile businesses are very important employers in their communities, (2) management has been straightforward in reporting on problems and energetic in attacking them, (3) labor has been cooperative and understanding in facing our common problems, and (4) the business should generate modest cash returns relative to investment." I further said, "As long as these conditions prevail - and we expect that they will - we intend to continue to support our textile business despite more attractive alternative uses for capital."

It turned out that I was very wrong about (4). Though 1979 was moderately profitable, the business thereafter consumed major amounts of cash. By mid-1985 it became clear, even to me, that this condition was almost sure to continue. Could we have found a buyer who would continue operations, I would have certainly preferred to sell the business rather than liquidate it, even if that meant somewhat lower proceeds for us. But the economics that were finally obvious to me were also obvious to others, and interest was nil.

The domestic textile industry operates in a commodity business, competing in a world market in which substantial excess capacity exists. Much of the trouble we experienced was attributable, both directly and indirectly, to competition from foreign countries whose workers are paid a small fraction of the U.S. minimum wage.

Over the years, we had the option of making large capital expenditures in the textile operation that would have allowed us to somewhat reduce variable costs. Each proposal to do so looked like an immediate winner. Measured by standard return-on-investment tests, in fact, these proposals usually promised greater economic benefits than would have resulted from comparable expenditures in our highly-profitable candy and newspaper businesses.

But the promised benefits from these textile investments were illusory. Many of our competitors, both domestic and foreign, were stepping up to the same kind of expenditures and, once enough companies did so, their reduced costs became the baseline for reduced prices industrywide. Viewed individually, each company's capital investment decision appeared cost-effective and rational; viewed collectively, the decisions neutralized each other and were irrational (just as happens when each person watching a parade decides he can see a little better if he stands on tiptoes). After each round of investment, all the players had more money in the game and returns remained anemic.

Thus, we faced a miserable choice: huge capital investment would have helped to keep our textile business alive, but would have left us with terrible returns on ever-growing amounts of capital. (Comment:  Gruesome business) After the investment, moreover, the foreign competition would still have retained a major, continuing advantage in labor costs. A refusal to invest, however, would make us increasingly non-competitive, even measured against domestic textile manufacturers.

My conclusion from my own experiences and from much observation of other businesses is that a good managerial record (measured by economic returns) is far more a function of what business boat you get into than it is of how effectively you row (though intelligence and effort help considerably, of course, in any business, good or bad). Should you find yourself in a chronically leaking boat, energy devoted to changing vessels is likely to be more productive than energy devoted to patching leaks.

There is an investment postscript in our textile saga. Some investors weight book value heavily in their stock-buying decisions (as I, in my early years, did myself). And some economists and academicians believe replacement values are of considerable importance in calculating an appropriate price level for the stock market as a whole. Those of both persuasions would have received an education at the auction we held in early 1986 to dispose of our textile machinery.

The equipment sold (including some disposed of in the few months prior to the auction) took up about 750,000 square feet of factory space in New Bedford and was eminently usable. It originally cost us about US$ 13 m, including US$ 2 m spent in 1980-84, and had a current book value of US$ 866,000 (after accelerated depreciation). Though no sane management would have made the investment, the equipment could have been replaced new for perhaps US$30 to US$ 50 m.

Gross proceeds from our sale of this equipment came to US$ 163,122. Allowing for necessary pre- and post-sale costs, our net was less than zero. Relatively modern looms that we bought for US$ 5,000 apiece in 1981 found no takers at US$ 50. We finally sold them for scrap at US$ 26 each, a sum less than removal costs."

Conclusion: The master's liquidation of his textile business shows what could potentially lie in store for a business with a rather poor economics, despite the presence of an excellent management. Thus, while Buffett was able to correct his mistake by devoting some of the textile company's capital to other more profitable businesses, no such luxuries await small investors. Hence, they can do their investment returns a world of good by refusing to invest in such businesses, no matter how cheap they might look based on book value and replacement costs.

Sunday 27 December 2009

Measurement in the Balance Sheet

Book values measurement determines the price-to-book ratio. To evaluate the price-to-book ratio, we must understand how book values are measured.


The values of some assets and liabilities are easy to measure, and the accountant does so. He applies mark-to-market accounting, thus recording these items on the balance sheets at fair value (in accounting terms). These items do not contribute to the premium over book value.


But for many items, the accountant does not, or cannot, mark to market. He applies historical cost accounting. U.S. GAAP gives measurement rules for items commonly found on balance sheets, with those carried at fair value and historical cost indicated. International accounting standards broadly follow similar rules.

-----

Example:


Company A Balance Sheet


Cash and cash equivalent $7.764 million
Short term investments $208 million
Long term investments (mainly interest bearing debt securities) $1,560 million.


Comment:  A market value is usually available for these securities, so they can be marked to market.


Accounts payable $11,492 million
Long term debt $362 million


Comment:  The accounts payable is close to market value and, while the long-term debt is not marked to market, its book value approximates market value unless interest rates change significantly.

So all these items above do not contribute to price premium over book value.


Net accounts receivable $5,961 million
Financing receivables $1,732 million
Accrued expenses $4,323 million
Other "liabilities" $2,070 million


Comment:  All the above 4 items involve estimates, but if these are made in an unbiased way, these items, too, are at fair value.




Company A
2,060 outstanding shares
Market Price $20 per share.
Market value of these shares: $41,200 million.
Book value $3,735 million
Therefore the market premium was $37,465 million.


Comments:
The market saw $37,465 million of shareholder value that was not on the balance sheet.
And it saw $37,465 million of net assets that were not on the balance sheet.
With 2060 million shares outstanding,
  • the book value per share (BPS) was $1.81 and
  • the market premium was $18.19 per share.


How does one account for Company A's large market premium of $37,465 million over the book value of its equity?


The large market premium of $37,465 million over the book value of its equity arises largely from
  • tangible assets, recorded at (depreciated) historical cost, and
  • unrecorded assets.
The latter are likely to be quite significant. Company A's value, it is claimed, comes not so much from tangible assets, but from
  • its innovative "direct-to-customer" process,
  • its supply chain, and
  • its brand name.
None of these assets are on its balance sheet.
  • Nor might we want them to be.
  • Identifying them and measuring their value is a very difficult task, and we would probably end up with very doubtful, speculative numbers.

Saturday 12 September 2009

Using Book Value in Making Investment Decisions

Going by the Book
Using Book Value in Making Investment Decisions

by Virginia B. Morris



Heading the list of questions investors sometimes struggle to answer is the perennial “What’s this stock worth?” The response is never simple, since there are several ways of assessing value. One of the most reliable ways is to use a combination of ratios, also called multiples. The BetterInvesting methodology employs the price-earnings ratio, which compares the stock’s price with its earnings per share.


Investors also measure a company’s stock price in relation to entries on its balance sheet. One of those ratios is price-to-book, or a stock’s market price divided by book value per share.

A stock’s book value, also called its net asset value and sometimes its shareholder equity, is key to figuring its price-to-book. Even if you don’t use price-to-book in your analysis, you should understand what book value is because it’s part of the calculation of return on equity, a key measure of management performance on the Stock Selection Guide.

Basically, book value is the company’s assets minus its liabilities, divided by the number of outstanding shares. The liabilities include the obligations the company has to its bondholders and preferred stockholders.

Some stock research companies report price-to-book over time, such as 10 years, as well as percentage growth in book value. You can also calculate book value on your own, using the company’s financial reports. You find net assets by subtracting the company’s short- and long-term liabilities from its assets. Then divide net assets by the number of outstanding shares to find the per-share results.

Two cautions: Check what’s being counted as assets. If intangibles such as goodwill or brand value are being included, those amounts should be subtracted to determine net assets. Also, as a related point, book value is more meaningful for companies that have actual physical assets that can be valued.

What P/B Tells You

Book value is important because it can help you determine whether a stock you may be interested in is underpriced and therefore potentially worth purchasing.

If the market price of a stock and its book value are the same, its price-to-book value is said to be 1. In that case, investors are paying exactly the value of the company’s reported assets. If the ratio is more than 1, they’re paying for past performance or what they anticipate the company’s future performance will be. That’s quite common, especially for companies with strong earnings.

Conversely, a ratio of less than 1 may indicate investors aren’t convinced that the assets the company is reporting are credible. It also may signal that the company’s performance has been disappointing or the stock is out of favor with investors for some other reason. Questionable valuation of assets, of course, is a reason to steer clear of the stock, while the latter instance, which is remediable, may be a reason to consider buying.

One for the Books

Both book value and price-to-book change constantly as a stock’s market value and the number of its outstanding shares continually fluctuate. As a result, these numbers are “snapshots” that report the present but can’t predict the future.

If you’re just beginning to investigate a stock, however, book value is a useful benchmark to watch as you track the issuing company over time. That’s especially true if you’re looking at a number of stocks in the same sector or industry, since the price-to-book value can be strikingly similar across companies of varying sizes in the same industry. One that’s out of sync may be a stock that merits closer attention.

As you study a stock, putting its price-to-book and percentage growth in book value in a historical context can be helpful in establishing a target price you’re o use this ratio want a sense of where the current price fits in relation to earlier highs and lows in helping them pinpoint a price range that would allow them to realize a satisfactory return.

Putting Value in Perspective

Book value and a price-to-book ratio, by themselves, should never be the single basis for making an investment decision, any more than the ROE, EPS or P/E should be. But each can be a valuable addition to your research toolbox, and used in combination they can provide a valid foundation for choice.



Virginia B. Morris is the Editorial Director for Lightbulb Press.


http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/0409abpublic.htm

Friday 11 September 2009

Buffett dwells on book value

Over long periods, a stock will move in tandem with company's performance. In the short term, there may be no correlation between the two.

Stock price movements are so fickle. You cannot and should not measure a CEO's performance based on how much the stock has gained from year to year.

Earnings are pliable and a CEO can manipulate them in dozens of ways to inflate a company's bottom line fro several years. Using restructuring charges, asset sales, write-offs, employee layoffs, or "asset impairment" charges, corporations can generously, and legally, cook their books and give the impression they are functioning on all cyclinders, when, in fact, they could be throwing their profits down the drain.

For all the reasons above, Buffett dwells on book value. Understanding changes in book value is key to assessing whether a company is truly worth owning, in Buffett's view.

Wednesday 8 July 2009

Book value and Intrinsic value

Warren Buffett observed that book value is the sum of what investor put into (or leave in) the business, while intrinsic value is what investors can take out of the business.

Book value or net worth is a key component of a company's intrinsic value.

But another and perhaps the more important component of intrinsic value is the net present and future income stream that a company can earn for the investor.

Therefore, the importance of looking at the balance sheet and also looking closely at income and income reporting, in your intrinsic valuation.

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Here is another Warren Buffett observation.

Apparently tired of answering questions about how to use book value to make investment decisions. Buffett pointed out the differrence between book value and intrinsic value: "Book value is what the owners put into the business, intrinsic value is what they take out of it."

In another explanation offered in a 1996 Berkshire Hathaway annual report, he likened book value to college tuition paid, with intrinsic value being the income resulting from the education. The education and the dollars spent on an education mean ntohing unless there is a resulting financial return.

The point: It is easy for investors to put too much emphasis on book value and not enough on intrinsic value.

Friday 12 June 2009

Price-to-book ratios and Superior Returns

PE ratios are not the only value-based criterion for buying stocks. A number of academic papers, begining with Dennis Stattman's in 1980 and culminating in the paper by Eugene Fama and Ken French in 1992, have suggested that price-to-book P/B ratios may be even more significant than PE ratios in predicting future cross-sectional stock returns.

Like PE ratios, Graham and Dodd considered book value to be an important factor in determining returns. More than 60 years ago, they wrote:

We suggest rather forcibly that the book value deserves at least a fleeting glance by the public before it buys or sells shares in a business undertaking..... Let the stock buyer, if he lays any claim to intelligence, at least be able to tell himself, first, how much he is actually paying for the business, and secondly, what he is actually getting for his money in terms of tangible resources.

Sunday 10 May 2009

3 measures of a stock's value

Value can be a subjective term depending on who is talking about it and how they measure values for themselves.

3 long-held fundamental measures of value are:

P/E
P/B
DY

Price: Price by itself without any other analytical factor is in fact worthless.

Earning: Earning can be a nebulous figure. Earnings can be modified and adjusted according to what the company's needs are. Sometimes if the company likes to have a different tax basis for one quarter, they may adjust their earnings up or earnings down. There are companies that depress earnings for one quarter and then lifted up earnings the next quarter to facilitate selling of stock options to important executives.

Earnings are what accountants say they are. P/E s are somewhat suspect, because earnings themselves can be suspects.

Book value: Book value also can be quite nebulous.

Often a company carries an asset at cost of 30 years to 40 years ago. Therefore, the book value does not give measure of true value of these assets of this company.

Dividend: Dividend tells us 3 things.

1. Dividend can only come as a result of earnings. In other words, company cannot pay what it doesn't have. In order for a company to pay dividend, it has to have earnings. This let us know that the company we are investing in, is a profitable concern.

2. Dividend represents income. It is a tangible return on your investment you receive every quarter. It is cash in your pocket. You can spend it on your needs, or you can reinvest that dividend into other dividend paying stocks and compound your returns.

3. Dividend helps us provide a basis for value. High quality stocks have some shared characteristics and repetitive patterns. These stocks tend to trade between 2 different bands of dividend yield. One band is when the price is low and the yield is high. The second band is when the price is high and the yield is low. Also, these stocks tend to trade in between these 2 bands over long period of time which gives us a good range to understand when to buy the stock and when to sell the stock.

To summarise: Dividend does 3 things.
1. It shows us our company is a profitable concern.
2. It puts income into our pocket.
3. It tells us when to buy and when to sell a stock.

http://articles.moneycentral.msn.com/learn-how-to-invest/new-investor-center-video-ap.aspx?cp-documentid=9d33155e-df9b-43b7-8535-9f2a8d87c769

Also read:
Why dividends are important for investors' portfolios.

Saturday 25 April 2009

Book Value: Theory Vs. Reality

Book Value: Theory Vs. Reality
by Andrew Beattie (Contact Author Biography)

Earnings, debt and assets are the building blocks of any public company's financial statements. For the purpose of disclosure, companies break these three elements into more refined figures for investors to examine. Investors can calculate valuation ratios from these to make it easier to compare companies. Among these, the book value and the price-to-book ratio (P/B ratio) are staples for value investors. But does book value deserve all the fanfare? Read on to find out.

What Is Book Value?

Book value is a measure of all of a company's assets: stocks, bonds, inventory, manufacturing equipment, real estate, etc. In theory, book value should include everything down to the pencils and staples used by employees, but for simplicity's sake companies generally only include large assets that are easily quantified. (For more information, check out Value By The Book.)

Companies with lots of machinery, like railroads, or lots of financial instruments, like banks, tend to have large book values. In contrast, video game companies, fashion designers or trading firms may have little or no book value because they are only as good as the people who work there.

Book value is not very useful in the latter case, but for companies with solid assets it's often the No.1 figure for investors.

A simple calculation dividing the company's current stock price by its stated book value per share gives you the P/B ratio. If a P/B ratio is less than one, the shares are selling for less than the value of the company's assets assets. This means that, in the worst-case scenario of bankruptcy, the company's assets will be sold off and the investor will still make a profit. Failing bankruptcy, other investors would ideally see that the book value was worth more than the stock and also buy in, pushing the price up to match the book value. That said, this approach has many flaws that can trap a careless investor.

Value Play or Value Trap?

If it's obvious that a company is trading for less than its book value, you have to ask yourself why other investors haven't noticed and pushed the price back to book value or even higher. The P/B ratio is an easy calculation, and it's published in stock summaries on any major stock research website. The answer could be that the market is unfairly battering the company, but it's equally probable that the stated book value does not represent the real value of the assets. Companies account for their assets in different ways in different industries, and sometimes even within the same industry. This muddles book value, creating as many value traps as value opportunities. (Find out how to avoid getting sucked in by a deceiving bargain stock in Value Traps: Bargain Hunters Beware!)

Deceptive Depreciation

You need to know how aggressively a company has been depreciating its assets. This involves going back through several years of financial statements. If quality assets have been depreciated faster than the drop in their true market value, you've found a hidden value that may help hold up the stock price in the future. If assets are being depreciated slower than the drop in market value, then the book value will be above the true value, creating a value trap for investors who only glance at the P/B ratio. (Appreciate the different methods used to describe how book value is "used up"; read Valuing Depreciation With Straight-Line Or Double-Declining Methods.)

Manufacturing companies offer a good example of how depreciation can affect book value. These companies have to pay huge amounts of money for their equipment, but the resale value for equipment usually goes down faster than a company is required to depreciate it under accounting rules. As the equipment becomes outdated, it moves closer to being worthless. With book value, it doesn't matter what companies paid for the equipment - it matters what they can sell it for. If the book value is based largely on equipment rather than something that doesn't rapidly depreciate (oil, land, etc), it's vital that you look beyond the ratio and into the components. Even when the assets are financial in nature and not prone to depreciation manipulation, the mark-to-market (MTM) rules can lead to overstated book values in bull markets and understated values in bear markets. (Read more about this accounting rule in Mark-To-Market Mayhem.)

Loans, Liens and Lies

An investor looking to make a book value play has to be aware of any claims on the assets, especially if the company is a bankruptcy candidate. Usually, links between assets and debts are clear, but this information can sometimes be played down or hidden in the footnotes. Like a person securing a car loan using his house as collateral, a company might use valuable assets to secure loans when it is struggling financially. In this case, the value of the assets should be reduced by the size of any secured loans tied to them. This is especially important in bankruptcy candidates because the book value may be the only thing going for the company, so you can't expect strong earnings to bail out the stock price when the book value turns out to be inflated. (Footnotes to the financial statements contain very important information, but reading them takes skill. Check out An Investor's Checklist To Financial Footnotes for more insight.)

Huge, Old and Ugly

Critics of book value are quick to point out that finding genuine book value plays has become difficult in the heavily analyzed U.S. stock market. Oddly enough, this has been a constant refrain heard since the 1950s, yet value investors still continue to find book value plays. The companies that have hidden values share some characteristics:

  • They are old. Old companies have usually had enough time for assets like real estate to appreciate substantially.
  • They are big. Big companies with international operations, and thus with international assets, can create book value through growth in overseas land prices or other foreign assets.
  • They are ugly. A third class of book value buys are the ugly companies that do something dirty or boring. The value of wood, gravel and oil go up with inflation, but many investors overlook these asset plays because the companies don't have the dazzle and flash of growth stocks.

Cashing In

Even if you've found a company that has true hidden value without any claims on it, you have to wait for the market to come to the same conclusion before you can sell for a profit. Corporate raiders or activist shareholders with large holdings can speed up the process, but an investor can't always depend on inside help. For this reason, buying purely on book value can actually result in a loss - even when you're right. If a company is selling 15% below book value, but it takes several years for the price to catch up, then you might have been better off with a 5% bond. The lower-risk bond would have similar results over the same period of time. Ideally, the price difference will be noticed much more quickly, but there is too much uncertainty in guessing the time it will take the market to realize a book value mistake, and that has to be factored in as a risk. (Learn more in Could Your Company Be A Target For Activist Investors? Or read about activist shareholder Carl Icahn in Can You Invest Like Carl Icahn?)

The Good News

Book value shopping is no easier than other types of investing, it just involves a different type of research. The best strategy is to make book value one part of what you look for. You shouldn't judge a book by its cover and you shouldn't judge a company by the cover it puts on its book value. In theory, a low price-to-book-value ratio means you have a cushion against poor performance. In practice it is much less certain. Outdated equipment may still add to book value, whereas appreciation in property may not be included. If you are going to invest based on book value, you have to find out the real state of those assets.

That said, looking deeper into book value will give you a better understanding of the company. In some cases, a company will use excess earnings to update equipment rather than pay out dividends or expand operations. While this dip in earnings may drop the value of the company in the short term, it creates long-term book value because the company's equipment is worth more and the costs have already been discounted. On the other hand, if a company with outdated equipment has consistently put off repairs, those repairs will eat into profits at some future date. This tells you something about book value as well as the character of the company and its management. You won't get this information from the P/B ratio, but it is one of the main benefits from digging into book value numbers, and is well worth the time. (For more information, check out Investment Valuation Ratios: Price/Book Value Ratio.)

by Andrew Beattie, (Contact Author Biography)

Andrew Beattie is a freelance writer and self-educated investor. He worked for Investopedia as an editor and staff writer before moving to Japan in 2003. Andrew still lives in Japan with his wife, Rie. Since leaving Investopedia, he has continued to study and write about the financial world's tics and charms. Although his interests have been necessarily broad while learning and writing at the same time, perennial favorites include economic history, index funds, Warren Buffett and personal finance. He may also be the only financial writer who can claim to have read "The Encyclopedia of Business and Finance" cover to cover.



http://www.investopedia.com/articles/fundamental-analysis/09/book-value-basics.asp


Also read: Nets and net net