Finding Value With the P/B Ratio

Timothy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The price to book (P/B) ratio is one of the most commonly used stock valuation metrics. To calculate this ratio you simply take the total market capitalization and divide by the book value of the company. Historically, companies with low P/B ratios have outperformed companies with higher P/B ratios over the long term. This allows the P/B ratio to be used as a way to find value stocks.

Like all simple ratios, the P/B ratio is nowhere near perfect. The book value includes intangible assets such as goodwill, patents, brand name, etc., which are inherently difficult (if not impossible) to value. These types of assets can be excluded, yielding the tangible book value, which may be more useful in certain cases. Another issue is that assets are typically recorded at-cost on the balance sheet instead of at-market. This can be especially inaccurate for assets like real estate that can appreciate in value significantly over time.

Because of these problems the P/B ratio offers a good way to find interesting value prospects, but should never be the only metric used. Often companies with low P/B ratios are undervalued by other reasonings, and vice versa for companies with high P/B ratios. I'll take a look at three companies that are trading at or below a P/B value of about 1 and see if they warrant further investigation.

Corning

The first company I'll look at is Corning (NYSE: GLW), which I've written about before. Using data from its most recent quarterly report here are the relevant figures from the balance sheet.

<table> <thead> <tr><th>Type</th><th>Value</th></tr> </thead> <tbody> <tr> <td>Current Assets</td> <td>$9,695</td> </tr> <tr> <td>Tangible Non-current Assets</td> <td>$18,184</td> </tr> <tr> <td>Non-tangible Non-current Assets</td> <td>$1,496</td> </tr> <tr> <td><strong>Total Tangible Assets</strong></td> <td>$27,879</td> </tr> <tr> <td><strong>Total Assets</strong></td> <td>$29,375</td> </tr> <tr> <td><strong>Total Liabilities</strong></td> <td>$7,842</td> </tr> <tr> <td><strong>Book Value</strong></td> <td>$21,533</td> </tr> <tr> <td><strong>Tangible Book Value</strong></td> <td>$20,037</td> </tr> <tr> <td><strong><em>P/B</em></strong></td> <td><strong><em>0.86</em></strong></td> </tr> <tr> <td><strong><em>P/TB</em></strong></td> <td><strong><em>0.93</em></strong></td> </tr> </tbody> </table>

All values except ratios in millions USD

Corning is trading at a discount to both the book value and the tangible book value. My previous article on Corning laid out an argument for Corning being undervalued based on a discounted cash flow calculation, so the low P/B ratio only makes the argument stronger. Historically Corning has traded at far higher P/B ratios, as can be seen from the chart below.

<img src="http://media.ycharts.com/charts/84e2644bb3f49ba7ed897400faa2a6c9.png" />

GLW Price / Book Value data by YCharts

While there's no guarantee that Corning will revert to the P/B values of the past, currently the ratio is below the lowest value from the financial crisis in 2009. There are a lot of signs pointing to Corning being undervalued.

Bunge, Ltd

Bunge (NYSE: BG) is a global agribusiness and food company, recording $60 billion in sales in 2012. Relevant figures from the most recent quarterly report are shown below.

<table> <thead> <tr><th>Type</th><th>Value</th></tr> </thead> <tbody> <tr> <td>Current Assets</td> <td>$14,065</td> </tr> <tr> <td>Tangible Non-current Assets</td> <td>$9,370</td> </tr> <tr> <td>Non-tangible Non-current Assets</td> <td>$646</td> </tr> <tr> <td><strong>Total Tangible Assets</strong></td> <td>$23,435</td> </tr> <tr> <td><strong>Total Assets</strong></td> <td>$24,081</td> </tr> <tr> <td><strong>Total Liabilities</strong></td> <td>$12,788</td> </tr> <tr> <td><strong>Book Value</strong></td> <td>$11,293</td> </tr> <tr> <td><strong>Tangible Book Value</strong></td> <td>$10,647</td> </tr> <tr> <td><strong><em>P/B</em></strong></td> <td><strong><em>1.01</em></strong></td> </tr> <tr> <td><strong><em>P/TB</em></strong></td> <td><strong><em>1.07</em></strong></td> </tr> </tbody> </table>

All values except ratios in millions USD

Bunge is trading at just about the book value, with intangible assets making up a very small portion of total assets. The current P/B value is below the historic value for Bunge.

<img src="http://media.ycharts.com/charts/383472a33b797487f0ed74aea06fbaa0.png" />

BG Price / Book Value data by YCharts

Although the book value points to Bunge being cheap the free cash flow has been spotty over the past decade, positive in only 3 of 10 years. The numbers for the recently reported 2012 are also negative, a reverse from positive numbers in 2011. This is an example where simply looking at the P/B ratio is not enough.

Royal Caribbean Cruises

Royal Caribbean (NYSE: RCL) is the second largest cruise company in the world, behind competitor Carnival. Here are the relevant figures from the most recent quarterly report.

<table> <thead> <tr><th>Type</th><th>Value</th></tr> </thead> <tbody> <tr> <td>Current Assets</td> <td>$888</td> </tr> <tr> <td>Tangible Non-current Assets</td> <td>$18,506</td> </tr> <tr> <td>Non-tangible Non-current Assets</td> <td>$433</td> </tr> <tr> <td><strong>Total Tangible Assets</strong></td> <td>$19,394</td> </tr> <tr> <td><strong>Total Assets</strong></td> <td>$19,827</td> </tr> <tr> <td><strong>Total Liabilities</strong></td> <td>$11,518</td> </tr> <tr> <td><strong>Book Value</strong></td> <td>$8,309</td> </tr> <tr> <td><strong>Tangible Book Value</strong></td> <td>$7,876</td> </tr> <tr> <td><strong><em>P/B</em></strong></td> <td><strong><em>0.95</em></strong></td> </tr> <tr> <td><strong><em>P/TB</em></strong></td> <td><strong><em>1.01</em></strong></td> </tr> </tbody> </table>

All values except ratios in millions USD

Royal Caribbean trades at 5% below book value. The difference between this company and a company like Corning is that most of Royal Caribbean's assets are tied up in ships. It's unclear what the actual market value of these ships are, but they may very well be far below the book value.

Historically the P/B value has fluctuated over the last decade, with a high above 2 and a low around 0.25. The current value is right around the average.

<img src="http://media.ycharts.com/charts/27df123ba406f3be4c75ab629f3840a7.png" />

RCL Price / Book Value data by YCharts

Because of this not much can be gained from looking at the P/B ratio for Royal Caribbean. Free cash flow was negative from 2006 through 2010, turning positive in 2011 and 2012. In 2011 the company generated $1.29 per share of FCF, while in 2012 this number dropped to just $0.41 per share. With a stock price around $36 per share the stock seems overvalued.

The Bottom Line

While the P/B ratio can be a useful number it can also be misleading. In the case of Corning the P/B points to an undervalued stock, in agreement with my previous discounted cash flow calculation. For Bunge and Royal Caribbean a low P/B ratio coupled with weak free cash flow leads me to believe that both companies are not particularly cheap. My conclusion is that the P/B ratio may be a good tool to find stocks that might be undervalued, but a more thorough analysis is necessary in each case. Investing by only using simple ratios is a recipe for disaster.


TheBargainBin owns shares of Corning. The Motley Fool recommends Corning. The Motley Fool owns shares of Corning. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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