In the world of investing, there are an overwhelming number of metrics, ratios, and statistics used to determine value and potential. As usually, the more we can simplify and boil down to the basic, the better our odds for success. We are all used to the familiar culprits; P/E ratios, ROE, Debt/Equity, etc. Most of these metrics can be useful tools. Like any tool, we must be aware of their limitations and used properly.
Comparing various metrics against each other to either validate or disprove a potential opportunity can be a useful method. For example, earnings per share (EPS) are a very common figure used by analysts and the media. However, the educated investor knows the EPS alone can be very misleading – accounting earnings can easily be manipulated. Therefore, in order to gain an understanding of what the number means, we might try overlaying trends in free cash flow (FCF) against EPS to verify the quality of those earnings.
One statistic that is usually overlooked is tangible book value per share. Many value investors consider it to be a very important figure to track and compare how fast the number should have grown over the past relative to how fast it’s actually grown. The difference in the growth of tangible book value and earnings can often reveal problems with sustainable growth. As we know, book value as an absolute number can be distorted with accounting adjustments, inventory inflation, historical asset valuation and so forth. So the number should always be adjusted for these potential distortions. Tangible, rather than just simple book value, will weed out intangibles such as a large goodwill entry on the balance sheet – exposing growth through acquisition. Using share based number allows us to incorporate the effects of any share dilution. Simply issuing more shares to grow book value doesn’t create wealth.
Take a quick review of Motorola’s BV per share since 2001. While there are many other factors to consider, the company has clearly destroyed a great deal of shareholder wealth.
Motorola | Book Value/ Share |
12/09 | $4.23 |
12/08 | $4.18 |
12/07 | $6.83 |
12/06 | $7.15 |
12/05 | $6.67 |
12/04 | $5.45 |
12/03 | $5.43 |
12/02 | $4.85 |
12/01 | $6.07 |
As is the case with any statistic, it shouldn’t be used in isolation and will not provide a magic bullet, but I do believe this quick snapshot will highlight some truly profitable companies. Furthermore, the growing tangible book value must be measured against earnings growth. A firm’s growing book value alone doesn’t signify anything without a sufficient and sustainable return on capital.
