Stocks: Cheaper by the Book
Price-to-earnings ratio, while arguably the most well-known of the equity valuation measures in the analyst's toolkit, isn't the only one. From time to time, we like to spotlight other metrics in this column. This week it's book value's turn.
First, a "book" review. Book value indicates the theoretical dollar amount per common share you might expect to receive from a company's tangible "book" assets should liquidation take place. Generally, book value is determined by adding the stated value of the common stock, paid-in capital, and retained earnings, and then subtracting intangible assets (excess cost over equity of acquired companies, goodwill, and patents), preferred stock at liquidating value and unamortized debt discount. Then divide that amount by the outstanding shares to get book value per common share.
The following stocks have a price-to-book ratio of no more than 1. A price-to-book ratio is used to compare a stock's market value to its book value, and is calculated by dividing the current closing price of the stock by the latest quarter's book value per share. In essence, you could buy these stocks for their book value per share—or even less.
One other wrinkle: A company trading at less than book value can, in theory, earn investors a profit if it is broken up or sold for its asset value.
Of course, sometimes there are good reasons why stocks are cheap, as market players may not see much upside in terms of potential return. And that's why we like to call in backup.
We at Standard & Poor's also have another means of determining whether stocks are properly valued—our fair value model, a proprietary quantitative stock ranking system. The model calculates a stock's weekly fair value—the price at which it should trade at current market levels—based on fundamental data such as corporate earnings and growth potential, return on equity, and current yield relative to the S&P 500—and yes, price-to-book value. Stocks are ranked from 5, indicating significant undervaluation, to 1, indicating significant overvaluation. We sifted for those issues ranked 5 under the model.
One final step: To make sure the names on our list were stable, liquid companies, we ensured each had a market capitalization above $1 billion and a stock price above $5.
Below are the four names that popped up. Note that the first three are insurance outfits, with the last name, Vishay, the outlier: It makes semiconductors.
|Aspen Insurance Holding (AHL)|
|IPC Holdings (IPCR)|
|Vishay Intertechnology (VSH)|