Companies with high Price/Book ratio

Brussels Sprout

Several months ago I read Christoper H. Browne's "The Little Book of Value Investing". A central tenet of the strategy in this book is to look for companies that have low Price/Book ratios as these represented

Just a brief aside for anyone unfamiliar with the terminology, the Book Value is essentially what you'd get if you were able to magically liquidate the assets of the company and use them to pay off all the debts (it can be a bit more complicated than this but this definition will suffice for the purpose of my question). This is also known as Stockholder equity and can be seen at the bottom of the balance sheet.

So the Book Value is the value of the company based on the figures in the balance sheet. This is then compared to the market capitalisation, which is essentially the market value of the company as judged by the price that people are willing to pay for its shares currently. The Price/Book is simply obtained by dividing one by the other.
Here are some P/B ratios for some well known companies:

Apple - 4.57
Alphabet - 4.21
Exxon Mobil - 2.57
Pfizer - 2.71
Yahoo - 1.11
Volkswagon - 0.58

I really like this metric as I think it offers some grounding for the otherwise meaningless share prices. However I have come across a couple of companies that have astronomical P/B's and I cannot figure out why. As in I can see the figures but I cannot understand why the market is continuing to value them so highly.

A case in point is Mastercard. In their latest Balance Sheet they have a Book Value of $6 Billion. However the Market Cap is $102 Billion giving them a P/B of nearly 17. It was a similar value the previous year. Compare that to their major competitor Visa who have a P/B of 6.

A more extreme example is the tobacco group Altria. They have a book value of $2.8 Billion but a market Cap of 120 Billion giving them a P/B of 42. Once again the book value has been of the same order of magnitude for the last number of years.

So my question is why is the market valuing these companies so much more than their accountants are?

For ever odd

A case in point is Mastercard. In their latest Balance Sheet they have a Book Value of $6 Billion. However the Market Cap is $102 Billion giving them a P/B of nearly 17. It was a similar value the previous year. Compare that to their major competitor Visa who have a P/B of 6.

What do you think the smart money would do when comparing the figure's? It should be jumping of the page, nice setup if the fundamentals are true.

daheff

you need to be careful looking at these types of ratios. Like all ratios, you need to understand the drivers of the constituent parts to fully understand what the ratio is telling you.


Take the example of Mastercard/Visa (as they are pretty much like for like competitors).

Hypothetially speaking (ie i dont know if the figures back me up)

Book value =Equity = Net asset value. IE how much the assets (including cash) of the entity are worth if you broken them up and sold them off.

Lets say Visa dont pay a dividend annually and Mastercard do. So this means that all profits each year are added to Visa's balance sheet. Lets say Mastercard pay our 100% of profits in dividends. So nothing is added to Mastercards balance sheet.

If both companies are making similar profits, the stock market would view Mastercard as a better company (return on equity) than Visa, so would price it up more. Also Mastercard would be paying a dividend, driving up demand for the stock. Thus the Price/ book value would be higher than Visa. Visa's equity would also increase as they keep adding cash to their assets each year. Market price wouldn't be so high and their Price/book ratio would be lower than Mastercard (but the stock market would still value Visa as a profitable stock -case in point being Ryanair. Up to recently they didnt pay dividends and retained all profits).



I'm not saying Visa/Mastercard operate in this fashion (probably somewhere in between).

JeffKenna

I would be using a tangible book value as opposed to book value ratio.

Also you need to be careful to use it in conjunction with other performance ratios...look at the oil penny stocks over the last year or so. Most had a very positive book value as they had lots of cash in the balance sheet. Yet most are gone now...

Francie Barrett

Price to book is a measure of valuing companies that is only useful in certain scenarios. In the extreme examples of high P/B stocks that you quoted, P/B isn't relevant because in these cases the value of the company is in the earnings/growth, and not the book value. Even when you use a traditional metic like Price/Earnings, Mastercard is still expensive (current PE is just under 30). This looks like a bubble like valuation, until you look at the earnings growth (15% per annum). In a 0% interest rate environment, the returns don't look so bad then, although for my tastes, I find Mastercard too expensive.

On the other end of the scale, you get companies with a very low Price/Book. One extreme example that I have looked at recently that is on the other end of the scale is Richardson Electronics - RELL (I have no interest in the company, I am only using it as an example in this context). This is a company that makes vacuum tubes for electronics. The company is in a structural decline (no one wants vacuum tubes in their electronics anymore), so revenues are falling, and the company is consistantly losing money. However, despite this, the company sells for less than a half the value of tangible assets. On paper at least, this is one of those companies that Warren Buffett would refer to as buying a Dollar for 50 cents. Unfortunately for shareholders though, the Chairman/founder of the company (and majority owner) controls the company and seems unwilling to wind down the company and re-distribute the funds to shareholders. When you get companies like this one, that are selling at low price/book ratio's and especially when the ratio is less than 1.0 - you have a company that has serious problems. When investors price up companies in trouble, they very often discount the price to book value, because they fear they won't even get the book value of the share they own back.

These are two examples on either extreme, but they will give you an idea that P/B isn't necessarily a good measure of whether a company is cheap or not.

OttoPilot

daheff wrote: »

Lets say Visa dont pay a dividend annually and Mastercard do. So this means that all profits each year are added to Visa's balance sheet. Lets say Mastercard pay our 100% of profits in dividends. So nothing is added to Mastercards balance sheet.

If both companies are making similar profits, the stock market would view Mastercard as a better company (return on equity) than Visa, so would price it up more. Also Mastercard would be paying a dividend, driving up demand for the stock. Thus the Price/ book value would be higher than Visa. Visa's equity would also increase as they keep adding cash to their assets each year. Market price wouldn't be so high and their Price/book ratio would be lower than Mastercard (but the stock market would still value Visa as a profitable stock -case in point being Ryanair. Up to recently they didnt pay dividends and retained all profits).

A non-dividend paying company would be valued more highly because 1. it reinvests money in its current business, saving on interest costs and 2. it doesn't pay taxes on the reinvestment whereas they will pay taxes on dividends.