Value Stock-Picking With Book Value

Companies like eBay (EBAY) and Amazon.com (AMZN) have made billions of dollars on a simple premise: People love bargains.

But what many people don't seem to realize is the bargain smorgasbord to be had in today's stock market.

A recent Forbes article claimed that the S&P is trading for 10% less than its fair value. And indeed, there are a few thousand stocks right now trading for less than book value. That's a pretty impressive number of investment bargains. Interested in cashing in?

Here's why book value might just be one of the most important metrics for 2008.

Book Value for Beginners

For the uninitiated, book value is basically a company's assets minus their liabilities and intangibles (like goodwill and patents). You can think of book value as a company's "net worth" -- higher book value means that a company has more assets and fewer liabilities, which is always a good thing.

Now when it comes to finding value plays, book value is a great tool to use in determining what a company is worth. The most important book value ratio is the price-to-book ratio (P/B). The P/B ratio takes the company's stock price and divides it by its book value per share.

So, why might knowing something like the P/B ratio be useful?

Well for starters, it can hint at whether a company is undervalued. If a stock trades for $10 per share, but its P/B ratio is $12, you've potentially got an attractive investment on your hands, with assets worth $2 more per share than you paid. While the P/B ratio will not give you an idea of how strong a company's product line is, it does tell you how much investment "insurance" you have. In other words, how much cash you could expect if the company were liquidated today.