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What Is Price-to-Book (PB) Value? Are Companies Trading At PB < 1 Value Plays?
Education | 06 December 2010
By: jason.liew
Articles (66) Profile

What is price-to-book value?

Price-to-Book value (“PB”) has a couple of definitions. From an investment and “layman” perspective, it refers to the balance left for the investors when a business is liquidated and the debts are paid. In order to calculate book value, one would use assets – liabilities on the balance sheet.

Generally, are companies trading at PB < 1 value plays?

For companies which are trading below book value (i.e. PB < 1), this technically means that the investors will get more than their investments back, assuming that the assets can be sold at the price reflected on the balance sheet. However, PB is less meaningful in manufacturing companies whose assets mainly constitute expensive equipment which are likely to depreciate rapidly. Furthermore, if these companies have equipment which are very specific to a niche in an industry, it may be difficult to find buyers unless they ascribe a large discount to the equipment. Thus, the PB for such companies may be overstated.

Conversely, for companies which have assets (such as land, natural resources eg. oil reserves) that are likely to appreciate over time, the PB for such companies may actually be understated. Such companies may present true value plays for investors.

Also, it is noteworthy that some of the company’s most valuable assets such as the company’s trademark / brand name, patents and copyrights etc that are developed internally in the company and company’s extensive distribution network have no book value. Therefore, focusing only on book value may preclude certain attractive investment opportunities.

What are some stocks that are trading way below their book value. Are they justified?

One company, Fuxing China came to my mind immediately. Based on 9MFY10 results, its book value per share is approximately SGD 0.247 (after taking into account the potential conversion of 34.5m conversion notes into shares and the conservative SGD/RMB exchange rate of around 5.20). Thus, at 3 Dec closing price of $0.160, Fuxing is trading at 0.65x PB.

Is this justified? Personally, I think investors may have ascribed a low valuation to Fuxing as firstly, it is a Chinese company which holds a lot of cash on its balance sheet. Its net cash per share amounts to around S$0.14 which constitutes a hefty 86% to the 3 Dec closing price of $0.16. As with any Chinese company, investors are wary of companies with such large cash hoard as they are uncertain whether this large amount of cash really exists.

Secondly, as a consequence of such large cash holdings, it has a significant drag on Fuxing’s return on equity. Based on the 9MFY10 results, Fuxing’s ROE is 4.4% which is very low.

Nevertheless, management has detailed concise plans on how to utilize its cash to generate higher returns for shareholders viz.

i) Capital expenditure – to increase production capacity in view of potentially higher orders;

ii) Acquisition – in talks with three companies providing electroplating services, colour dying services and dyed yarn supplying business so as to be a fully integrated zipper manufacturer;

iii) Share buybacks and dividend distribution of not less than 40% of its net profit.

If management really can fulfill the aforementioned plans on the cash utilization to generate higher returns for shareholders, then the low PB may not be justified.

Readers who would want to know more about Fuxing China can refer to my previous article at http://www.sharesinv.com/articles/2010/11/08/fuxing-net-cash/


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