Book values are something I often think about as an investor, but haven't really ever taken the time to write about properly. They're one of the key metrics I look at - familiar readers will remember I often highlight a company's PTBV (price to tangible book value) in my main metrics tables, and several of my screens exclude firms trading at too high multiples of their book. On the other hand, some of the companies my portfolio owns don't have particularly impressive book values - that is to say, I paid more for the company than I actually received in tangible assets. In this case, then, it may appear that I'm throwing money down the drain. What gives? Well, here I'll attempt to highlight two main ways I think about book values and how they help my analysis of a company.
A signal of safety
First and foremost, a low book value can be seen as a signal of safety, especially from the point of view of equity investors. We're last to receive money in the event of a liquidation - being subordinate to debt holders, like the banks. This means that with companies trading on book values of less than 0 - with debts exceeding assets - we won't see any of our investment should everything go bottoms up. Price to tangible books of between 0 and 1 suggest that the market is valuing the business at less than the value of all its assets, and a liquidation may actually return more than you paid for the business - that is to say, a business trading on a market cap of £5m with no debt and £10m worth of property would return all that capital (minus liquidation fees) to shareholders as the owners of the business. That's an ideal scenario, but almost impossible to find - if the market really believes a company will be liquidating itself, there's probably a good reason it isn't valuing it at is apparent liquidation value. This is all a little nuanced, though, because for most businesses we invest in liquidation isn't really on the cards. Instead, book value just helps us to understand the business faster - with both particularly low and high book values leading us to ask particular questions.
High book value:
Does this business have a durable competitive advantage? If I'm paying a 8 times tangible book value, I believe…
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