New Ventures Society


  Price to Book


Prior to the consolidation of the banking system into a few big players it was common to have small local banks formed with local citizens as the initial shareholders. When the charter was issued everyone would subscribe to the shares at book value. The resulting market price was usually twice to three times the book value reflecting the liquidity of the investment and the potential earnings capacity.
In general the market price for public companies runs about three times the book value. Examples are Wal-Mart and Macy. Even Exxon sells at 2 times book in spite of all the problems with the oil industry.


Of course exceptions abound. IBM has a value of 11 which is really overvalued for a company on the verge of bankruptcy, For years the management has been buying back the shares using the retained earnings from decades previous plus vast sums borrowed from banks. It has rewarded the executives with vast options which became profitable with rising price of the shares. So sales are down, investment and research are canceled, employees are being let go, and the shares are rising in price (earnings are divided by fewer shares). The company has reached the point where the book value consists almost exclusively of Good Will (excess price paid for companies bought) and Intangibles. Just like General Motors or Radio Shack before their bankruptcy.


Even further into insanity is Sears. This fine old company consisting of Sears and Kmart has an advertised book value of minus $22 a share. It sells for $16! This is the result of a buy out by a liquidation specialist which has been selling off assets and closing stores right and left. It makes a profit from management fees and will eventually end up robbing the pension plans and bond holders in a very legal manner.


On the other end of the scale is Amazon. The price to book runs around 23 and the price to earnings was around 950 (it has since dropped by actually having earnings). So extreme is this valuation that if Amazon were to sell stock amounting to 10% of its outstanding shares it would triple the book value of the existing shares. Investors are discounting the hereafter. There is no way that Amazon can corner the retail industry market, but it is making a valiant effort. This is what happens when Wall Street becomes enamored with an idea. All rational thought is abandoned and we have Unicorns valued at billions that have never made any money.


The big banks tend to be valued at just a bit over book value. With the financial crisis they run around 0.7 to 1.2 with the worst, Deutsche Bank, down at 0.25. Of course the problem is determining what is their actual book value. They have "assets" that run over 100 times their capital, and the quality of those assets is questionable. Loans to foreign governments, loans on oil leases when oil was selling for $100 a barrel that are now worthless with oil at under $40, loans that are current only because the companies receive new loans to pay off existing loans, loans on real estate that is in default but no foreclosure is made because the bank does not want to record the loss. All in all the banks are teetering on massive bankruptcy with the likes of Deutsche Bank and Monte dei Paschi threatening the solvency of all the banks in the world. All tied together through derivatives that may suddenly become worthless if the contra party goes belly up.


The AP has reported that 75% of the Standard and Poor's companies cheat on the reported earnings. They are required to file GAAP earnings with the SEC but the earnings that reach the press are full of statements reflecting continuing operations, excluding extraordinary actions, and the capitalization of expenses. This is how the book value becomes filled with zero real value items, software development that is capitalized instead of expensed and other sham transactions. General Electric was noted for having extraordinary items every year for decades.


All in all Wall Street is a gigantic Ponzi scheme, with the Federal Reserve pumping in money to raise the price of stocks even though earnings have been declining for years. Main Street businesses are being sacrificed for International businesses, and America is being hollowed out. And when it busts it will take jobs with it, along with pension plans (investing in big stocks), mutual funds (stocks again) and even the real estate industry (overvalued housing).


The only advice that can be given is make money while you can, and then diversify and build a survival reserve. Just like the extremely wealthy. When will it all come apart? No one knows, perhaps the Fed will keep the ball in the air for years to come, one boom after another.