For the majority of investors who will not or cannot devote the painstaking time to extensively research an investment idea, there is a simple approach that, over time, should deliver satisfactory results: investing in stocks trading below book value.
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Good Book Vs. Bad Book
By simply exerting effort to determine whether book value is good or bad, investors can build a list of quality investment ideas. Book or equity, value is just that, the residual value left over for stockholders. So if a company has book value of $1 million and is trading for a value of $600,000, that's an intriguing situation. The simple task is to determine what that $1 million in equity is made up of. If it was mostly cash, accounts receivables or other high quality assets like modern machinery and facilities, that's good book value.
SEE: Reading The Balance Sheet
But if the equity value is made of assets that aren't that attractive, then the equity value may be overstated. For example, Barnes and Noble (NYSE:BKS) trades at 76% of book value of $820 million. Yet, the bulk of the company's assets are made up of inventory, which is predominately books that are often marked down in order to compete with Amazon (Nasdaq:AMZN). This is an example of bad book value.
Callaway Golf (NYSE:ELY) is well known for their golf products, and trades at 83% of book value. More so, Callaway has a great balance sheet that is free of debt. Assets consist of a balanced mix of cash, receivables, inventories and intangibles. Given the value of the brand name, I wouldn't completely dismiss the value of the brand.
Wolverine Bancorp (Nasdaq:WBKC) is a small-cap bank trading for 57% of tangible book value. Yet unlike the uncertainty surrounding the mega-cap financials, Wolverine is a recently converted thrift with a relatively clean balance sheet, no subprime loans or any other exotically named financial product. Based in Michigan, the concern is the overall economy in the state but Wolverine benefits as Michigan climbs up from rock bottom. In the meantime, the overcapitalized balance sheet leaves the door open for buybacks and dividends.
The Bottom Line
Buying stocks at a discount to book value has a history of rewarding investors. The key is to not get duped by a book value that is weak or meaningless.
SEE: 5 Must-Have Metrics For Value Investors
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At the time of writing, Sham Gad did not own shares in any of the companies mentioned in this article.