Calculating Intrinsic value – Book value

Introduction

In a previous post, I briefly listed several methods of calculating the intrinsic value of a share. These included the following methods:-

  • Book Value Per Share
  • price = value
  • market multiples
  • True value as adjusted book value plus assessment of competitive advantage plus future growth
  • Roger Montgomery method
  • Brian McNiven / StockVal Method

Another method that I neglected to mention was Aswath Damodaran’s valuation method.

In today’s post, I’m going to discuss Book Value Per Share in more detail. I’ll discuss the others as well as Aswath Damodaran’s method in more detail in future blogs as each method deserves its own blog piece.

Book Value Per Share (BVPS)

Book value per share is the theoretical value of the company if you realised all the assets, paid out all the liabilities and then had something left over to give to shareholders, in other words the Net Assets of the company (which also happens to be the value of Shareholders Equity). Note that BVPS includes both tangible (e.g. property) as well as intangible (e.g. goodwill) assets.

How to calculate Book Value Per Share

Simply get the Net Assets value from the companies last report. Have a look at the balance sheet, otherwise known as the “Statement of Financial Position”. Since Net Assets will equal the Equity, you could also ge tthe Equity figure. Now go and find the latest number of shares the company has outstanding. (Not including convertibles, options, preference shares etc). Divide the Net Assets or Shareholders Equity by the total number of shares. This will give you the “book value” of the company per share.

When using this method, you usually compare the current share price to the BVPS, and determine if the share price is at a discount or a premium to BVPS, or Share price / BVPS. A value greater than 1 means the stock is trading at a premium to book value, and thefore if result is less than 1, the share price is at a discount to book value. You might also see this ratio referred to as “Price to Book”, or “P/B”. Most stocks trade at premiums to their book value, those that trade at discounts usually do so for a valid reason, for example, the last stated book value is no longer representative of the company’s net assets.

Now that you have Book value per share and the price to book ratio, what do you do with them? As with most ratios, one value is not going to help you much, so you need to compare these ratios to other stocks, both in the same or similar sectors, as well as comparing the ratios to companies in completely different sectors. All things being equal, you’d then try to find the companies with the best ratios, so those with the lowest price to book value, or those trading at a discount to book value, and then try to find out why there’s a discount.

The following table lists several stocks selected at random, and shows whether the current price is a discount or premium to book value.
As you can see, several stocks are trading at discounts to their book value.

Company (ASX code) Shares Net Assets Book
Value
Current
Price
Price to
Book
Discount /
Premium
A V Jennings (AVJ) 274.6 304.7 1.11 0.50 0.45 55% Discount
ANZ Bank (ANZ) 2,596.8 34,155.0 13.15 21.84 1.66 -66% Premium
Aristocrat (ALL) 536.5 187.9 0.35 2.63 7.51 -651% Premium
Billabong (BBG) 254.0 1,173.7 4.62 5.82 1.26 -26% Premium
Cochlear (COH) 56.7 487.4 8.59 79.97 9.31 -831% Premium
CSL (CSL) 532.3 3,902.9 7.33 33.98 4.63 -363% Premium
Hills Holdings (HIL) 249.1 496.5 1.99 1.35 0.67 33% Discount
Macquarie Group (MQG) 346.8 9,108.0 26.26 33.55 1.28 -28% Premium
Matrix Composites (MCE)  77.1 84.5 1.10 8.44 7.69 -669% Premium
Qantas (QAN) 2,265.1 6,030.0 2.66 2.11 0.79 21% Discount
Sigma Pharmaceuticals (SIP) 1,178.6 832.9 0.71 0.38 0.54 46% Discount
Westpac Bank (WBC) 3,009.6 42,119.0 13.99 21.78 1.56 -56% Premium

As you can see several stocks are trading at discounts to book value. Theoretically, if you could buy the whole company and realise the assets and liabilities, you could make a profit. However, in real life this would not be how it would work. Some assets may not be worth what they are valued at on the balance sheet, some assets such as deferred tax benefits may not be able to be realised. Some assets may have no value to anyone else, intangible assets may be worth nothing or could even be worth several times what they are valued at on the balance sheet.

The main point to note is that it is possible for the company to be trading at a discount to book value for no real valid reason. Therein lies the opportunity, as well as several hours of research into why its trading at a discount. Eventually the market should come to value the company at or above its book value, or the company will have to write down the value of its assets further.

One very quick check to perform when looking at stocks trading at discounts to book value is to check how much cash and liquid investments they have on the balance sheet. Very infrequently, some companies can trade below their cash per share value, making them an almost foolproof opportunity.

What to watch out for

  • Minority interests – if the company is complex and has multiple joint-ventures, subsidiaries and equity accounted interests, trying to calculate the true book value may be almost impossible.
  • Preference shares that should be treated as debt, not equity – Many companies issue preference shares, debentures etc, that should be treated as a liability rather than equity. You may need to adjust the net assets total before working out the book value per share.
  • Off balance sheet assets and liabilities – As an example, Qantas (QAN) has loads of debt off-balance sheet, so its true book value is not the same as the net assets shown on the company’s balance sheet.
  • Partial holdings in subsidiaries or Joint venture companies, usually called equity accounted investments – Companies can use these vehicles/companies to hide assets & debt.
  • Intangibles – what actually makes up intangibles? Is it goodwill, brand names, licences, agreements etc. Sometimes companies have accumulated lots of goodwill, but it may have less economic value than recorded on the balance sheet, especially if the company has been making expensive acquisitions.
  • Accounting treatment of depreciation – does the company follow standard industry methods?
  • Stocks listed on multiple exchanges e.g. BHP, Rio, NewsCorp. BHP & Rio are both listed on the Sydney and London stock exchanges, so you need to make sure that you have the correct number of shares when calculating book value per share.
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