Stock Prices and Book Value
Posted: Mon Oct 13, 2008 5:12 pm
I'd suspect it's redundant to point the fact out to any investors who read this forum, but recent decreases in stock prices have produced a situation where some of the Standard and Poor's 500, are actually selling at below the usual calculated figures for book value. A circumstance like this only occurs every decade or so. Some calculations suggest that over half of the S&P 500 are selling at below book value. That is, the total value of a company's outstanding stock, is, at current prices, less than the value of the company's assets less its liabilities. If you can stand watching the value of your portfolio yoyo up and down, there is a reasonably good chance that the prices of stocks currently selling at below book value, will increase substantially in the next year, and some stocks might be considered good buys at the present time, even if the market as a whole goes down substantially for a while. The potential increase in value over the next year could actually be independent of economic conditions for some companies.
Book value is, of course, the total value of a corporation's assets, less its debts. These valuations are necessarily approximate, but you can generally figure that calculated values are within a few percent of actual value, because a company's assets and liabilities can be identified from its balance sheet. Since valuations go up and down, book value is not an absolute figure, but you can normally figure that it will remain pretty much the same unless assets are sold or new debt is incurred. Because the value of assets is less subject to business conditions than earnings, stocks selling at prices near book value, should be less volatile than those which are selling above book value.
There is of course no way of knowing what will happen to stock prices, but it seems to be a reasonably good bet that the corporations with valuations less than book value will increase to book value or above, simply because other corporations will try to buy up stock in undervalued companies, with the goal of eventually obtaining the assets.
Usually, companies with large real estate holdings (mostly not single-unit residential properties) are among those which have the most attractive assets when the companies are selling at below book value. These can include railroads, which typically own a considerable amount of property, some retailers which own their own stores, real estate trusts or holding companies, forest product companies, and other types of businesses which require considerable amounts of land or a large number of buildings in order to carry on their businesses. This used to include automobile manufacturers, but companies like GM and Ford now have difficulties which have compromised their values, and their asset bases have been eroded. I've personally increased my investment in publicly traded stock recently, but wouldn't make any specific recommendations to other investors. You have to study the balance sheets of companies, assess the potential for the economy in the next couple of years, and decide what level of risk you are willing to assume. There will probably be big profits for those who choose wisely, and who hold their stock past the present period of volatility.
The economy actually doesn't look to be in that bad a shape, apart from the financial sector and a few types of companies like the automakers and companies in the housing sector, which had some problems before the financial problems of the last month or two developed. If credit availability can be restored, the recession which appears to have started, may not be as severe as some have predicted. Restoration of credit availability and confidence in the economy may take some time, but there is a possibility for recovery in the first half of next year.
As to whether the various bailout measures will work, to restart lending by banks, it's difficult to say. Some people have suggested that a solution like the one adopted in Iceland, and adopted to some extent in at least one European country, in which the government temporarily takes control of the banks, would work, simply because the government could then order the banks to lend money. It should be understood that banks actually do have money to lend--they simply are afraid to lend it because of economic uncertainty. Lending could of course be restarted if the U.S. government took control of the larger banks in this country, but once the banks were taken over, you would have the problem of whether they would ever be returned to private ownership or control. A lot of people would argue that, since banks create money (If you don't know how this happens, look at web pages on "notational money," "notational value," or "notational currency.") the banking system is actually carrying out a function that properly ought to be the function of government, and therefore the banks ought to be controlled by government. But, of course, once government nationalizes the banks, they become subject to political manipulation.
In any case, nobody should panic. The real economy is still there and providing all sorts of good things for us, even if the bankers have made a botch of things.
Book value is, of course, the total value of a corporation's assets, less its debts. These valuations are necessarily approximate, but you can generally figure that calculated values are within a few percent of actual value, because a company's assets and liabilities can be identified from its balance sheet. Since valuations go up and down, book value is not an absolute figure, but you can normally figure that it will remain pretty much the same unless assets are sold or new debt is incurred. Because the value of assets is less subject to business conditions than earnings, stocks selling at prices near book value, should be less volatile than those which are selling above book value.
There is of course no way of knowing what will happen to stock prices, but it seems to be a reasonably good bet that the corporations with valuations less than book value will increase to book value or above, simply because other corporations will try to buy up stock in undervalued companies, with the goal of eventually obtaining the assets.
Usually, companies with large real estate holdings (mostly not single-unit residential properties) are among those which have the most attractive assets when the companies are selling at below book value. These can include railroads, which typically own a considerable amount of property, some retailers which own their own stores, real estate trusts or holding companies, forest product companies, and other types of businesses which require considerable amounts of land or a large number of buildings in order to carry on their businesses. This used to include automobile manufacturers, but companies like GM and Ford now have difficulties which have compromised their values, and their asset bases have been eroded. I've personally increased my investment in publicly traded stock recently, but wouldn't make any specific recommendations to other investors. You have to study the balance sheets of companies, assess the potential for the economy in the next couple of years, and decide what level of risk you are willing to assume. There will probably be big profits for those who choose wisely, and who hold their stock past the present period of volatility.
The economy actually doesn't look to be in that bad a shape, apart from the financial sector and a few types of companies like the automakers and companies in the housing sector, which had some problems before the financial problems of the last month or two developed. If credit availability can be restored, the recession which appears to have started, may not be as severe as some have predicted. Restoration of credit availability and confidence in the economy may take some time, but there is a possibility for recovery in the first half of next year.
As to whether the various bailout measures will work, to restart lending by banks, it's difficult to say. Some people have suggested that a solution like the one adopted in Iceland, and adopted to some extent in at least one European country, in which the government temporarily takes control of the banks, would work, simply because the government could then order the banks to lend money. It should be understood that banks actually do have money to lend--they simply are afraid to lend it because of economic uncertainty. Lending could of course be restarted if the U.S. government took control of the larger banks in this country, but once the banks were taken over, you would have the problem of whether they would ever be returned to private ownership or control. A lot of people would argue that, since banks create money (If you don't know how this happens, look at web pages on "notational money," "notational value," or "notational currency.") the banking system is actually carrying out a function that properly ought to be the function of government, and therefore the banks ought to be controlled by government. But, of course, once government nationalizes the banks, they become subject to political manipulation.
In any case, nobody should panic. The real economy is still there and providing all sorts of good things for us, even if the bankers have made a botch of things.