As value investors we constantly search for stocks that are selling below their intrinsic value. Estimating the intrinsic value of any stock turns out to be much more of an art than an exact science. There are many ways of going about it. Here we will consider one such metric: Price to Tangible Book Value Ratio.
What is Tangible Book Value?
You have probably used the P/B Ratio or Price to Book Value to value stocks. This is one of the favorite valuation metrics of most value investors, perhaps second only to the P/E ratio. However, the P/B ratio suffers from one critical shortcoming.
Many company balance sheets are stuffed with assets that do not physically exist. For example, goodwill, or value of the patents or r&d. Other intangibles may include customer lists, or brand value. Many a times a company has acquired another and paid a premium for these intangible assets, which is how these things end up on the acquiring company’s balance sheet. When the going is good, strong arguments can be (and indeed, are) made to support the ascribed value to these intangibles. But what if we are a value investor picking apart the balance sheet to see what the parts of the company sum up to?
Book value gets you close to the intrinsic value of the company. However, a liquidation of the company will not be kind to the values given to the intangibles. In most cases, these values are aspirational, and have no basis in the reality of the market. Tangible Book Value gets you even closer to the intrinsic value by minimizing or in many cases completely eliminating the intangibles.
Tangible Book Value, TBV = Book Value – Goodwill – Other Intangible Assets
Alternatively, you can also express this as
Tangible Book Value = Total Assets – Goodwill – Other Intangible Assets – Total Liabilities
You can similarly calculate the Tangible Book Value Per Share as TBV/Shares Outstanding.
What is Price to Tangible Book Value?
If you like your price to book values less than 1, looking for stocks with price to tangible book value less than 1 will give you deeper values and better investments. We are not implying that goodwill and intangibles are worthless, we are just saying that let’s assume they are worthless and use this more stringent criteria to look for value stocks.
Price to Tangible Book Value is simple a ratio of the Price per share of the stock with the Tangible Book Value Per Share.
Price to Tangible Book Value (P/TBVPS) = Price / Tangible Book Value Per Share
Why Tangible Book Value is Important for Stock Market Investing?
Tangible book calculation gives you a much more conservative estimate of the intrinsic value compared to the book value of a company. This means that an investor is less likely to end up investing in a company that looks a great value on the surface but is actually stuffed with intangibles that may never justify their valuation in the market. It is one way of marking to the market and as a result investments that arise from this analysis are likely to be safer.
Additionally, the calculation of tangible book value and price to tangible book value ratio requires the investor to consider each component of the asset on the balance sheet and make an independent judgement of value for that asset. It introduces additional rigor in the valuation process and helps eliminate errors.
Finally, it helps the investor value a company in a way similar to what a business competitor will do when they evaluate this company for acquisition. Investing like a sophisticated investor is a very important skill as many value stocks finally realize their full value once they are acquired by a competitor or by its own management.