Deep Blue Publications Group :What Is Book Value? - 0 views
started by Yahnie Miller on 29 Nov 13
started by Yahnie Miller on 29 Nov 13
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started by Yahnie Miller on 29 Nov 13
Book value can mean various things to various people. For instance, book value on the invest pedia blog, at the time of writing, has three meanings.
As an investor, the one meaning that matters is the second definition:
"(Book value is) the net asset value of a company, computed as the total assets minus intangible assets (patents, goodwill) and liabilities."
This definition is fine if you like jargon. Let me illustrate it using a different approach.
Book value is computed from the balance sheet. The balance sheet is one of three sets of financial statements that investors assess as part of the evaluation process before investing in a company.
The other two remaining financial statements are the income statement and the cash flow statement.
How the Price-to-Book Ratio Can Make You a Successful Investor
Is the price-to-book ratio the closest thing to a holy grail?
Judge for yourself: Tweedy, Browne Company LLC reported that a successful stock market strategy (page 3) based on the price-to-book ratio with exceptional results. The Deep Blue Publications Group LLC utilizes the price-to-book ratio in the valuation process.
What Is The Price-To-Book Ratio?
The price-to-book ratio is the first financial ratio I view when analyzing a business for prospective investment.
The price-to-book ratio is a gage of how much the shares are trading as compared to its book value.
As a tip, a handy method to compute book value is to find the total equity figure (or total stockholders' equity for the US) found right at the bottom of the balance sheet and subtract (minus) goodwill and intangibles, found at the top of the balance sheet under non-current assets.
To round it off, I have presented the Tesco balance sheet below. You can compute book value for yourself. If you do not have time, keep going; you can try it anytime in the future.
Market Share and Economies of Scale
Since studying stock price movements provides very little help in predicting long-term results, I prefer to talk about two very closely connected things that are intrinsic in business which I consider in order to guide investment decisions:
The first: high variability - is something that is existing in businesses that my partnership, more often than not, will try to avoid.
The second: economies of scale - is a key characteristic we search for in companies that we eagerly seek to be a part of.
Before the year 2008 ended, 36% of cell phones purchased around the world were made by Nokia.
Samsung was a far second holding 15% of the market share; but the difference between the two companies was much greater when it came to a unique category of cell phone we now know as smart-phones which were designed as portable mini-computers with Internet capability.
At the same period of time, Nokia had an even more commanding 41% market share of smart-phones than Samsung which had a pitifully small share of 2%.
By 2012, just less than three years later, smart-phones had become the ruling kings and what previously was known as regular cell phones are rapidly becoming ancient relics with practically no profit margins left to show.
Today, business schools ordinarily teach us that "economies of scale" often means that there is an inherent benefit in being the company with the biggest market share because that company has the advantage of having the lowest operational cost.
Market leadership can be utilized to undercut competitors in price (or get a price premium without sacrificing volume), create better product features, increase budget for marketing and distribute products over a wider marketing network.
In short, economies of scale make it very difficult to outpace a market leader.
Obviously, the opposite is just as true.
Nokia's market share in smart-phones has dipped to 5%, while Samsung is now the global leader at over 30%. What happened? Why was Nokia overtaken? And, perhaps, equally as vital, why was Nokia outclassed so overwhelmingly within a short period of time?
The simple answer is that during this period, Samsung opted to build up their phones based on an exceptional computing platform created by Google, called Android, while Nokia did not.
While this is essentially true, it is a partial explanation.
Since a smart-phone basically means the addition of a many more computer features to one phone, there are now far more obstacles that you have to hurdle simultaneously to keep on selling phones.
At present, the operating system, the graphic interface, the screen resolution, the hardware design, the camera resolution, the energy efficiency, the computing power, and the support of the service provider are all equally essential to a new phone buyer.
Even if you obtain a 95% chance of getting each of these eight features right for any particular phone, this still leaves you with about a 34% chance of market failure (1 - 0.95^8), if we considered all variables as equally important.
This does not even take into consideration variables not related to the product itself, such as marketing and retail strategy.
To complicate the matter, the average length of time of ownership of a cell phone is only 20.5 months, meaning to say that a cell phone company has to not only be consistent in getting all of these many variables right every time, they also have to hope that new features are not introduced by other players and that they can better predict the right mix of delightful variables year after year.
At the same time, the prices of previous year's products decrease by 50%, removing all margins for error for new products.
In contrast to this is a product like Coca-Cola, which customers actually demand to remain constant decade after decade even though they drink it on a daily basis.
It comes as no surprise then that the consumer electronics industry is littered with many past market leaders that are now radically weaker like Nokia, Sony, Motorola, Nintendo, HP and RIM, while the beverage industry continues ever more to be dominated by Coca-Cola and Pepsi.
You have probably noticed that the general media are often overly thrilled to cover high-variable industries, such as consumer electronics, consumer internet services, video gaming, teen fashion retail, hotels, restaurants, airlines and motion pictures. The reason is that these industries are continually evolving, thus creating so much hype, intrigue and anticipation for the public at large.
These industries can always be depended upon to create breakthroughs into fresh innovations that can determine the fortunes of the various participants in an instant.
Naturally, this is the exact opposite of what we desire to have.
As long-term investors, we are on the look-out for businesses with high degrees of predictability. We want companies that can dependably remain dominant over the long-term.
One of the best ways to pinpoint such companies is to find those that do possess economies of scale.
Hence, it follows that to possess a sustainable advantage of scale; a business must have very few variables to consider.
The cost structure of the business should also be inclined towards having fixed expenses (e.g. electricity, factory overhead) that do not rise in proportion to rising sales. In short, there should be few variables that will affect both the revenue side and the cost side. And if you look at industries where these two conditions exist, the winners are quite often expectedly the same and new players hardly ever appear.