Question for the fundamentalists out there

Warren Whitmore · #1 03-22-2003, 07:36 PM

From kiplinger "...in some industries-insurance and finance, for example book value per share isn't considered particularly significant. In general, when the figure is available, you want it to be on the low side."
This makes no sense to me why would I want it to be on the low side?

adios · #2 03-23-2003, 03:57 AM

I'm not sure what Kiplinger means but here's my take. BV means a lot less for companies like Microsoft than it does for companies like say Annaly Mortgage. In the Microsoft case the first thing is that MSFT's most valuable assets are intangible assets that don't show up on the balance sheet. Microsofts most valuable asset is their source code seeing that the source code is the most important asset for driving revenue and earnings. The value of source code is nowhere to be found on it's balance sheet or any other software companie's balance sheet.

Annaly is a mortgage REIT who invests their cash in Mortgage Backed Securities (MBS) who uses a "carry trade" to leverage their cash. The leverage ratio they use is about 10-1. They borrow 10 times their cash at a very low rate and purchase MBS with that money and make money off of the spread between the rate they borrow at and the rate that the MBS pay. This is very similar what a bank does when it pays depositors a lower rate than what they lend money at. BTW bank leverage ratios tend to be much higher than 10-1. There isn't much intangible value in a company like Annaly Mortgage except for what management brings to the table in their expertise in managing a portfolio of MBS but bear in mind that management expenses are quite high. Also Annaly's portfolio is quite liquid. Therefore a company like Annaly should trade much closer to BV and it does.

In reality BV probably isn't that important in valuing the vast majority of companies on the exchanges. I do like to look at the balance sheet though and scrutinize the assets and liabilities of companies. It's time consumming and I'm not sure how much money it really makes you. Generally speaking BV is used as a metric in valuing the value of companies, sectors and indexes.

Wildbill · #3 03-23-2003, 04:15 AM

People are getting into book value today and here is something to think about. There are some companies out there that are extremely aggressive about buying back shares. I used to work for a company that went all out buying back shares, to the point that treasury capital was actually negative. How we did that was by taking out a big loan (notes issuance) at what was a great rate that helped us exploit our strong credit rating. If we cared about book value it would have been stupid to do that, but frankly book value is not worth much for healthy companies. Paying for shares with profits is nice, but many times buying back shares with debt is excellent for your returns and should be undertaken as long as you don't overdo it. To the play it safe investor today that gets too caught up in book value, that might be a company he thinks is run by idiots, but in corporate finance theory its an excellent way to beat your return on capital hurdle rates and should add value for your shareholders.

If you pay attention to these things, you will notice book value is only brought up for companies that are running quite poorly. Further its used quite poorly, someone saying "Company X is below book value!!" while completely ignoring its financial situation and commitments. Look, its nice to think if the doors closed tomorrow the shareholders could get more money than they pay for the stock today, but its terribly unrealistic. Keep in mind companies always have tons of contractual obligations to their suppliers, to their employees, to their landlords, etc. Those must be paid and yet book value pays that no heed. Book value also is a terribly backward way to look at numbers. That includes every dollar of profit ever made, but its not like that is cash sitting around for the company. They reinvest it and it may not be worth anything close to what they paid for it and it could be generating far less than they expected of it. Also book value is just an accumulating number. A business that has been around since 1920 may have a huge number there, while its competitor only started up in 1995. Does book value matter here??? The company from 95 could be kicking their booty right now because they took losses first 5 years really developing a deep market and product and now it pays off. The old company now has its solid book value which makes for a great ratio because its stock is trading down. Why it trades down so low? Precisely because the young turk has come in and is making the old company's future look very cloudy.

I can't believe that this has happened, the obsession with book value. I have a degree in accounting, but work in finance these days. I can tell you if you are an investor that the future is where its at. Forget all this past stuff, the emphasis on accounting is going too far. If there is fraud, yes that is an issue, but remember that financial statements are really useful to investors for one thing and that is to make educated guesses as to what might happen in the future. These newly fashionable investors that spend all their time looking at financial statements for last 3 years and then calculate ratios based on things like book value are not going to be terribly effective. They will win some and lose some, but their methods aren't going to do anything earth shattering. Investments are future based, always always always. Forget yesterday, it means very little if you are buying the stock today. And at least for today, the market is always right, once again always always always.

The most money made in the market is by the people that properly spot growing companies, not cheap companies, and then move out of them when their particular growth story plays itself out. That is where the money is. The money isn't in saying Company X should be valued at $10, but the stupid people in the market only see it worth $7. That is the attitude of the petulant school child, rarely does this person get anything done on their schedule. Sure they could make money in the very long run, but only after the company finds the wind finally at its back and it becomes this growth story that I speak of. If you want to be a value investor over the long run, just be a Peter Lynch and find something you like for the long run and buy it when those moments of opportunity come up and it trades below its usual valuation. That will fit your needs, but once again that is a method that pays little heed to book value or accounting numbers and pays more to the markets it serves and the demand you expect for its product.

I know a lot of people will argue about it, but these facts are very much true. The market isn't a perfect financial world, there are emotions that are stoked by the common thinking of the time. Why else would such a silly metric as book value be getting so much play by even people that ignored it a few years ago??? Believe me, book value is about as useless as it can get. Its a backward looking number and one that has little useful application at that. Put it simply, if someone thinks they can find a business that could close the doors and have more cash left over than trading value today, be very very skeptical. They frankly cannot possibly know that is true. While companies do disclose most commitments, they can easily miss some that add up. Further unless you really think companies close the doors and don't pay a penny in severance and stiff their creditors across the board, remember there are liabilities that are incurred daily and they must be paid. So once again, please heed my advice and pay little attention to book value if you want to find good investments.

scalf · #4 03-23-2003, 12:21 PM

[img]/forums/images/icons/smile.gif[/img] mister softy makes a real product, but it's real value is due to it's intellectual property..(source code)...hmmmm..amazing that you would admit there is value due to intellectual property...although, msft does actually sell a msft product..even though it is useless without placement in a far more expensive product....

think msft was smart to defend their source code and fight with ftc...was the millions paid lawyers worth it???

hmmm?

jmho..gl [img]/forums/images/icons/smile.gif[/img] [img]/forums/images/icons/spade.gif[/img]

scalf · #5 03-23-2003, 12:30 PM

[img]/forums/images/icons/smile.gif[/img] scalf's thoughts on book value...

people want it now because it is (supposedly) something tangible; something they can (supposedly) sell if company (or overall market tanks)...

big problem is: book value is highly subjective and volatile..note the big write-offs among computer firms when stuck with tangible real objects...they lost value as cheaper competition became available....or take a look at punch presses in auto plants...get replaced by more efficient, robotic, computer controlled, metal forming devices....

in banking...a lotta companies try hard to max assets, but there has to be a balance between risk/loan reserves/ and the evaluation of risk in loans is subjective...

in short, ya want a company that is likwly to vastly increase earnings in near future..jmho..gl [img]/forums/images/icons/crazy.gif[/img] [img]/forums/images/icons/cool.gif[/img] [img]/forums/images/icons/club.gif[/img]

Warren Whitmore · #6 03-23-2003, 02:29 PM

"In the short run the market is a voting machine; in the long run, it's a weighing machine."
"I try to buy securities that are undervalued based on assets more than earnings. I do a better job on assets than earnings because earnings have a way of changing."
I have always felt that the analogy between a persons individual finances and the market is: assets are to net worth as earning are to ones pay check. In poker terms this means I would rather buy "stock" in Ray Zee than in Stu Ungar because in the long run Ray is going to have more money even though Stu is capable of earning more. This seems contrary to all of the responses that I have recieved so far. Thanks for the responses as I have learned a few things in the area of non accountable assets.

adios · #7 03-23-2003, 05:12 PM

Well if there's something that I know anything about it's software and software development. Giving away the source code is giving away too much so yes I think they did right thing by refusing to divulge their source code. Apparently I've posted some negative MSFT stuff. IMO the issues about MSFT revolve around whether or not they are an illegal monopoly. My understanding of anti-trust laws is that it's ok to be a monopoly as long as the monopoly status is obtained legally. Many court cases regarding anti-trust laws and only one I believe has not supported this view. However, in a peculiar way I don't like investing in software companies as a rule. But yes IMO MSFT's most valuable asset is their intellectual property in the form of source code.

Wildbill · #8 03-23-2003, 05:16 PM

Book value and assets aren't one and the same. And his theory is exactly what I say, either buy something long because you see value in the markets its products server, or live in the short run buying stocks that are in the right zone of a growth spurt and then sell when the story isn't as strong. While no one can argue that Buffett doesn't have a great track record, remember the numerous edges he has over the average investor. Namely, if you go out and buy shares of a company, you can't influence or help out their management much. Warren has resource that can help. Maybe Coke isn't calling for help, but a lot of his smaller companies have benefitted from his capital and his people's financial knowhow. It allows them to become focused on the entrepreneurial side that they are best at, not the financial day-to-day which sinks a lot of even good businesses. So while you might be able to spot some good valuation bargains, don't start believing they will lead to untold riches. And I guarantee you Warren doesn't care about book value either. I know he is a strong believer in ROI and efficient financial management. Neither of these are based on book value.

adios · #9 03-23-2003, 05:24 PM

I'm not doubting that Buffet said that but I'm wondering what book you found it in. I'd like to read it if you'd be so kind to pass it on.

Every book I've read on valuation more or less states that the assets dedicated to the conitinuing operation of a business should basically have a value of zero dollars. The books don't put it quite this way but that's the meaning. The rational is that corporations are assumed to run in perpituity i.e. forever. So the break up value of assets dedicated to continuing operations will never become an issue (certainly an acquirer like Buffet can buy them though [img]/forums/images/icons/smile.gif[/img]).

I would look at lots of balance sheets to learn about assets and liabilities.

Warren Whitmore · #10 03-23-2003, 07:16 PM

The name of the book is "Warren Buffett speaks" its has lots of fun quotes in it. Here are a few
1)My health is terrific. I just went for the first time in six or seven years for a general checkup. The doctor asked me about my diet and said, your counting rather heavily on your genes aren't you?
2)Investing in a market where people believe in efficiency is like playing bridge with someone who has been told it dosen't do an good to look at the cards.
3)I have seen no trend toward value investing in the 35 years I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult."