Value Stock-Picking With Book Value

Looking for a bargain? Here's why a company's book value might be one of the most important metrics right now.
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Companies like eBay (EBAY) - Get Report and Amazon.com (AMZN) - Get Report 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

.

A P/B ratio of 1 would mean that a company is trading at a price equal to its assets per share, but ratios over 1 are commonplace. That's because there are a whole lot of other factors that play into stock prices, including future

earnings

, market sentiment, and the company's intangibles. It's when the book value gets

below

1 that things get interesting.

Trading at a Discount

It may be hard to fathom how a company could trade for less than its worth. That would be like buying a company that has $100,000 in the bank

for $75,000

-- not a bad buying position to be in, if you ask me. But the fact of the matter is that values are relative. There could be a lot of reasons

why

a company is trading cheap.

And while I hate to be the bearer of bad news, the truth is you've probably sold off assets for a lot less than their book value. Just think about the last time you used a penny. Specifically, consider the pennies minted before 1982 -- they have a shockingly low P/B of 0.377. That's right, pre-1982 pennies actually contain 2.65¢ worth of copper (1¢ price

divided by

2.65¢ value

equals

0.377 P/B ratio), meaning that if you spend a few pennies the next time you buy a newspaper or a pack of gum, you could be throwing away valuable money.

The same is true of stocks. With tons of factors weighing in on stock prices, it's certainly not impossible for an otherwise healthy company to trade below its book value.

And that seems to be exactly what's going on these days on Wall Street -- at least for now.

Left and right, stock market legends like Warren Buffett and John Bogle are telling investors that now's a great time to buy stocks. "Instead of having a market price of seven times book value, the market price

of the S&P 500 is twice book. The market relative to the book value and

dividends

it pays is far cheaper than it's been in a long time," Bogle said in a recent

MarketWatch

interview.

And that's not just the case in America right now.

According to Martin Morris of the U.K.'s

Telegraph

, one-third of stocks on the country's

large-cap

FTSE 100 index are trading at a discount to book value. According to Morris, "fifteen of the FTSE 100 companies are now trading at less than half of their book value, with troubled

Royal Bank of Scotland

(RBS) - Get Report

ranked the lowest."

Where Book Value Falls Short

Remember, though, book value isn't the end-all, be-all when it comes to valuing companies on Wall Street. One area where book value really falls short is in valuing intellectual property-based companies that are heavy on intangible assets, such as a

Pfizer

(PFE) - Get Report

or

Google

(GOOG) - Get Report

.

And even if book value is an accurate measure of a company's worth, it's not something that should be looked at on its own. Metrics like the

P/E ratio

,

EPS

, and

beta

of a stock can be just as important for your investment decision as book value is.

Right now, price-to-book is a low number for all kinds of stocks. Big companies like

Bank of America

(BAC) - Get Report

,

ConocoPhillips

(COP) - Get Report

, and

Vodaphone

(VOD) - Get Report

are all trading for a fraction of what they're worth, and many smaller stocks can be had for even less.

So, looking for a bargain? The real deals are in the stock market.

Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.