What is book value? Are companies trading at P/BV < 1 value plays?

From time to time, I would be invited by Nextinsight, financial website http://www.nextinsight.net/index.php/story-archive-mainmenu-60/903-2010-/3253-just-ask- to answer queries from their readers. Here is the latest answer by me to a reader asking about Book Value plays.
Q1. What is book value?
Book value (“BV”) has a couple of definitions. From an investment and “layman” perspective, it refers to the balance left for the investors when a business is liquidated and the debts are paid. In order to calculate book value, one would use assets – liabilities on the balance sheet.
Generally, are companies trading at P/BV < 1 value plays?
For companies which are trading below book value (i.e. P/BV < 1), this technically means that the investors will get more than their investments back, assuming that the assets can be sold at the price reflected on the balance sheet. However, P/BV is less meaningful in manufacturing companies whose assets mainly constitute expensive equipment which are likely to depreciate rapidly. Furthermore, if these companies have equipment which are very specific to a niche in an industry, it may be difficult to find buyers unless they ascribe a large discount to the equipment. Thus, the P/BV for such companies may be overstated.
Conversely, for companies which have assets (such as land, natural resources eg. oil reserves) that are likely to appreciate over time, the P/BV for such companies may actually be understated. Such companies may present true value plays for investors.
Also, it is noteworthy that some of the company’s most valuable assets such as the company’s trademark / brand name, patents and copyrights etc that are developed internally in the company and company’s extensive distribution network have no book value. Therefore, focusing only on book value may preclude certain attractive investment opportunities.
Q2. What are some stocks that are trading way below their book value. Are they justified?
One company, Fuxing China came to my mind immediately. Based on 9MFY10 results, its book value per share is approximately SGD24.7 cts (after taking into account the potential conversion of 34.5m conversion notes into shares and the conservative SGD/RMB exchange rate of around 5.20). Thus, at 3 Dec closing price of $0.160, Fuxing is trading at 0.65x P/BV.
Is this justified? Personally, I think investors may have ascribed a low valuation to Fuxing as firstly, it is a Chinese company which holds a lot of cash on its balance sheet. Its net cash per share amounts to around S$0.14 which constitutes a hefty 86% to the 3 Dec closing price of $0.16. As with any Chinese company, investors are wary of companies with such large cash hoard as they are uncertain whether this large amount of cash really exists.
Secondly, as a consequence of such large cash holdings, it has a significant drag on Fuxing’s return on equity. Based on the 9MFY10 results, Fuxing’s ROE is 4.4% which is very low.
Nevertheless, management has detailed concise plans on how to utilize its cash to generate higher returns for shareholders viz. i) Capital expenditure – to increase production capacity in view of potentially higher orders; ii) Acquisition – in talks with three companies providing electroplating services, colour dying services and dyed yarn supplying business so as to be a fully integrated zipper manufacturer; iii) Share buybacks and dividend distribution of not less than 40% of its net profit.
If management really can fulfill the aforementioned plans on the cash utilization to generate higher returns for shareholders, then the low P/BV may not be justified.
For readers who would want to know more about Fuxing China, they can refer to http://ernest15percent.com/index.php/2010/11/08/fuxing-backed-by-014-of-net-cas/

The information contained herein is the writer’s personal opinion and is provided to you for information only and is not intended to or nor will it create/induce the creation of any binding legal relations. The information or opinions provided herein do not constitute an investment advice, an offer or solicitation to subscribe for, purchase or sell the investment product(s) mentioned herein. It does not have any regard to your specific investment objectives, financial situation and any of your particular needs. Accordingly, no warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of this information. Investments are subject to investment risks including possible loss of the principal amount invested. The value of the product and the income from them may fall as well as rise. You may wish to seek advice from an independent financial adviser before making a commitment to purchase or invest in the investment product(s) mentioned herein. In the event that you choose not to do so, you should consider whether the investment product(s) mentioned herein are suitable for you. The writer will not, in any event, be liable to you for any direct/indirect or any other damages of any kind arising from or in connection with your reliance on any information in and/or materials appended herein. The information and/or materials are provided “as is” without warranty of any kind, either express or implied.  In particular, no warranty regarding accuracy or fitness for a purpose is given in connection with such information and materials.

Leave a Reply

Your email address will not be published. Required fields are marked *