Investing Below Book Value

By Sham Gad | April 25, 2011 AAA

The goal in investing is to pay less than what a business is worth. One way investors attempt to do that is investing in stocks trading below book value. Strictly speaking, book value is defined as the net worth of a company. Deduct a company's liabilities from its assets and what you are left with is "net assets" also referred to as equity or book value. While such an investment approach is simplistic and not a guaranteed recipe for investment success, it does offer a lot of promise.

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Good Assets
The largest steel company in the world, Arcelor Mittal (NYSE:MT), currently trades at a price to book ratio of 0.90. While MT has intangible assets and goodwill on the balance sheet, as the largest steel company on the planet those intangibles clearly have value. Profits are expected to surge over the next year as shares sport a forward P/E ratio of less than 9. Another titan in its industry is cement company Cemex (NYSE:CX). Shares trade for $9 and the P/B ratio is 0.55. Cemex is highly levered, however, with a market cap of $9 billion and an enterprise value of $26 billion. Operations have been hurt by a weak infrastructure market, but earnings could spike quickly as a result of the leverage.

Fallen Giants
Names that used to be market darlings now find themselves trading wide discounts to book. Bank of America (NYSE:BAC) is one such company that trades at 60% of book value. The only problem is that no one really knows the true book value for BAC since it still sits on troubled loans. At the same time, it's likely that current loans are of much better quality, and this should bolster earnings over time.

Considered one of Japan's iconic companies, Sony Corp (NYSE:SNE) now trades for $29 a share versus book value of nearly $36. More so, Sony has a solid balance sheet showing $17 billion in cash versus $12.5 billion in debt. The company is launching two new tablet computers in its efforts to benefit from the surge in demand from this new product category. (For more, see Do Tablet Wars Signal Apple's Decline?)

Book Value Trap
Investing in names below book value is not a bulletproof approach. But it can present some ideas especially for a company with solid cash generating assets. (For more, see our Understanding Book Value Video.)

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