The late Ben Graham, author of the "Intelligent Investor" and "Security Analysis", and mentor to Warren Buffett, often advocated buying enterprises that were trading below book value.
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Margin of Safety
Because book value represents net asset value, or the value of the assets minus all liabilities, it's easy to understand why Graham favored this approach. Having lived through the Great Depression, Graham was exposed to the vicissitudes of the stock market. One way to ensure a margin of safety is by investing in businesses that were trading below net asset value, so if a business went under, equity holders would not be completely wiped out. Separately, Graham especially favored stocks trading below net current asset value, since current assets like cash and receivables were more liquid than long-term assets. (For a quick refresher, check out Value By The Book.)

Let's focus on a few names trading for less than tangible book value. Tangible book value eliminates assets like goodwill and provides another layer of safety for the equity holder.

Valuable Industrial Plays
First up is an incredibly cheap little gem, Horsehead Holding Corp (Nasdaq:ZINC). As the stock symbol implies, Horsehead produces zinc-based products. Shares currently trade at a discount relative to tangible book value of $7.72 a share. Of that book value, $2.73 is in cold hard cash and the company is virtually debt free, with only $105,000 in debt. The hidden value here is the property and plants, which are worth far more than $149 million as stated on the balance sheet. Horsehead owns modern plants that recycle electric arc furnace dust, a hazardous by-product of the steel industry. Building such a plant today, when you consider lag time and environmental regulatory costs, could easily reach hundreds of millions of dollars.

Oil refiner Tesoro (Nasdaq:TSO) currently has a market cap of $1.8 billion against hard book value of approximately $3 billion. At $13 a share, tangible book value comes to $21 a share based on 138 million shares outstanding. Refineries take years to build and there hasn't been a new refinery built in the US for over 30 years. Big refiner Valero (NYSE:VLO) also trades for $16 a share against hard book of about $30. Mr. Market doesn't seem to care for refiners now, but at 50% of book they may be an interesting long-term bet.

Cash-Rich Shoes
Look at athletic shoe maker K-Swiss (Nasdaq:KSWS), which has such a pristine balance sheet it can't be ignored. Shares trade for $8 against book value of $9.20 a share. Over $5 is in cash. The market cap is $280 million and net cash is over $175 million. The giant in the space, Nike (NYSE:NKE), currently trades at over three times book value. Nike's phenomenal branding and marketing deserve a premium valuation, but cash-rich K-Swiss seems to warrant at least a P/B multiple of 1 to 1.5. (For more, see Introduction To Fundamental Analysis)

Bottom Line
Buying companies below tangible book value can be a wonderful strategy to earn excess portfolio returns. To be sure, not all book values are created equal. But when you have cash-rich balance sheets or large, stable enterprises with years of solid operating performance, you will likely do well by owning a handful of these types of businesses. (For further reading, see Digging Into Book Value and Finding Solid Buy-And-Hold Stocks.)



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Tickers in this Article: KSWS, ZINC, VLO, TSO, NKE

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