Book It -- We Can Find Values

1/30/2012


Value investors seek companies selling for less than they are worth. Price/earnings and price/cash flow ratios value companies relative to the results of their operations, but the price/book ratio takes a more direct approach.

Book value of equity reflects the value of a company's assets, minus the value of its liabilities. In theory, if you sold the assets at their stated value and satisfied the liabilities, you'd be left with the book value. As such, a stock trading below book value is technically selling for less than it is worth.

Of course, book value isn't perfect. For one thing, it focuses on the accounting value of assets rather than market value. Book value, which is based on historical costs, probably underestimates the true asset value of most companies. In addition, companies with more liabilities than assets can have a negative book value. As is the case with earnings, negative book value makes the metric irrelevant for valuation. Still, the price/book ratio has proven effective at identifying winning stocks.

In rolling 12-month periods since 1994, the one-fifth of S&P 1500 Index stocks with the lowest positive price/book ratios have averaged returns 3.9% higher than those of the average stock in the index. Stocks that look cheap based on the ratio of the current price/book to three- or five-year norms also tend to outperform.

STOCKS CHEAP RELATIVE TO BOOK VALUE
The eight A-rated stocks below all sport price/book ratios below the S&P 1500 Index average of 2.6 and also trade at a discount to their three- and five-year averages and the current industry average. Stocks recommended for purchase are presented in green.
Book
Value of
Equity
($Bil.)
Stock-
Market
Value
($Bil.)
------- Price/Book Ratio -------
Company (Price; Ticker)
Recent
3-Yr.
Avg.
5-Yr.
Avg.
Ind.
Avg.
Industry
Apache
($98; APA)
26.7
37.5
1.4
1.8
1.9
2.0
Oil/Gas
Exploration
App. Materials
($12; AMAT)
8.8
16.1
1.8
2.2
2.7
2.1
Semiconductor
Equipment
General Dynamics
($71; GD)
13.6
25.4
1.9
2.0
2.3
2.8
Aerospace
& Defense
Hewlett-Packard
($29; HPQ)
38.6
56.6
1.5
2.2
2.5
3.1
Computer
Hardware
J.P. Morgan
($38; JPM)
175.8
143.1
0.8
0.9
1.1
2.0
Financial
Services
Nippon Telegraph
($25; NTT)
103.9
66.0
0.6
0.8
0.9
2.7
Telecom
Services
Target
($51; TGT)
15.3
34.1
2.2
2.3
2.6
3.1
Generall
Merchandise
Zimmer
($57; ZMH)
5.6
10.1
1.8
1.9
2.4
3.0
Health Care
Equipment
Note: Averages exclude price/book ratios below 0 or above 15.

The table above lists eight A-rated stocks with price/book ratios below the average of 2.6 for S&P 1500 stocks. Each also trades at a discount to its three- and five-year average, as well as the average for its industry. Visit www.DowTheory.com/Go/Book for a list of all S&P 1500 Index companies that meet those criteria. Two attractive values are reviewed below.

During the first nine months of 2011, Apache's ($98; APA) production jumped 18%, on pace to top the company's 2011 estimate of 13% to 17%. The independent energy producer operates 86 rigs and hundreds of onshore wells worldwide and will soon be even bigger. On Jan. 23, the company announced plans to purchase Cordillera Energy Partners for $2.85 billion in cash and stock, giving Apache access to 254,000 acres along the Texas-Oklahoma border. Apache expects the deal to add to earnings and boost production by more than 2% immediately. Over time, Apache plans to drill about 160 new wells on the property.

In 2011, drilling on U.S. soil contributed to the outsize growth. This year, international operations should set the pace with project ramp-ups in Canada and Egypt and an Australia field back at full speed after cyclone activity last year. The consensus projects profit growth of 32% in the December quarter and 8% in 2012. The latter target seems conservative given Apache's operating momentum.

Apache holds more than 21 million acres in the Gulf of Mexico, and the resumption of deepwater drilling should support production growth over the next several years. While the Gulf drilling moratorium was lifted in October 2010, slow permitting weighed on 2011 production. However, in the September quarter, Apache received approval to drill on four blocks. And three projects should start producing during the March quarter. At 1.4 times book value, Apache trades at a 28% discount to its five-year average and the average for its industry. Apache, slated to release December-quarter earnings Feb. 16, is a Long-Term Buy.


Hewlett-Packard ($29; HPQ) shares have slumped 39% over the last year, hurt by weak quarterly results, market concerns about the personal-computer industry, high-profile management problems, and lackluster performance of new products. In the wake of that bad news, the world's largest PC maker looks cheap from just about any direction. At 1.5 times book value, H-P trades at a discount of 42% to its five-year average and 51% to its industry average. The stock's price/earnings, price/sales, and price/cash flow ratios are also at least 47% below five-year norms.

Of course, some of H-P's discount is warranted. The company has little presence in the high-growth mobile-computing market. PC shipments declined more than 1% industrywide in the December quarter, while H-P's shipments fell 16%. And former eBay ($32; EBAY) CEO Meg Whitman, just four months into her tenure at the helm of H-P, is still reshaping the company's executive corps.

Couple these company-specific issues with a possible European recession, and the profit decline of 16% expected for the fiscal year ending October 2012 sounds plausible. Yet H-P shares appear priced for worse results. The company's balance sheet remains strong and its businesses viable, albeit out of favor. The consensus projects per-share-profit growth of 11% in fiscal 2013, and a little good news would go a long way for H-P. The stock is a Long-Term Buy.


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