When Low Book Value Can Be Misleading

Negative or low book value shouldn't always be treated as the destruction of value

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Apr 03, 2020
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Some say book value has lost its meaning in the past decade or so, as there are myriads of stocks with extremely low or even negative book value, such as McDonald's, which have outperformed the market consistently. Has it lost its meaning? What's happening here?

For traditional value analysis tools, like net-net or price-book ratio, it is a matter of concern, because these tools are intended to assess the operating profitability of the companies over time. For example, Mattel Inc (

MAT, Financial) has been sustaining losses in the last couple of years and consequently, it diminished the retained earnings of the company, which led to diminished book value and negative tangible book value.

However, the relevance of these tools is debatable for different companies in a different context. Though the metric still be useful for certain types of companies, some investors even went as far as to suggest to drop book value altogether.

Regardless of who's right and wrong, let's explore some situations or actions that can lead to low or negative book value.

1. Repurchase programs or dividends: At the end of 2017, Qualcomm (QCOM) had a total stockholders equity of $30.7 billion, while at the end of 2018 it was reduced to less than $1 billion thanks to $22.5 billion in share buybacks and $3.5 billion in dividends distributed. The financial statement impact would be reduced cash and short term investment on the asset side while retained earnings, which is the amount of accumulated income after paying out shareholders, would be reduced. This, in turn, will make the company look good in assets, equity or invested capital based metrics.

2. Goodwill impairment test: Goodwill is a type of intangible asset created through M&A activities and recorded when the carrying value is more than the fair value. It is subject to an annual impairment test. Perhaps one of the most recent examples would be the one of General Electric (GE, Financial) writing off $22 billion in 2018 that contributed to “disappearance” of $100 billion in book value.

3. Divestitures: Perhaps this is one of the most obvious reasons why and how book value can be reduced. This can be done to unlock value. For example, eBay (EBAY) had a book value of almost $24 billion in 2014 that was reduced to almost $6 billion in 2016 because of the PayPal (PYPL) divestiture. Both stocks ended up doing more than fine.

4. Property owning companies: O’Reilly (ORLY, Financial) is one of the largest specialty retailers of automotive aftermarket parts, tools, supplies, equipment and accessories in the United States, selling their products to both do-it-yourself and professional service provider customers. Even though it is one of the best S&P 500 stocks in the past decade or so, its book value has been decreasing over time. This is because these companies operate like a real estate investment partnership, and of the 5,219 stores that they operated at Dec. 31, 2018, O'Reilly owned 2,119 stores and leased 3,026 stores. This is a giant real estate company whose property value increases over time while they are required to report the value at the original cost after depreciation. This leads to a huge misunderstanding about their business model and similar companies.

5. Intangible asset-based companies: For many human capital based companies such as software companies and consulting companies, it is common to have low tangible assets, which leads to low or negative book value. However, for companies like LVMH Moët Hennessy (LVMH, Financial), aka Louis Vuitton, how do you quantify their brand value? There's no scientific way to do it. For brand-based companies, it is also common to see a depressed book value.

6. Negative other comprehensive income: Negative other comprehensive income can lead to negative book value. There are several different types of negative other comprehensive income. One is the fluctuation of unrealized loss on bonds, which can be bad especially for insurance companies who take a large exposure to the bond market. Another is foreign currency exchange losses or unfavorable currency fluctuation, which can put multi-national corporations in a very uncomfortable area. A decrease in a pension plan or post-retirement benefit plan can cause the related portfolio of investments to have lower book value


So how do you measure book value after all? How do you even define it beyond the definition provided by regulating bodies?

The answer is as subjective as it can be, as the book value on the financial statement is almost always not the same as the true value of the equity. To take things a step further, I'd even argue that although it is hard to quantify, factors such as a large barrier of entry, wider moat in the form of patents, government regulation, decreased competition and backlogs should be treated as equity in the minds of a value investor. Book value on paper can be useful, but it should always be put into context first.

Disclosure: I don't own any of the stocks mentioned and do not have intention to own in the near future.

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