CHAPTER 14: THE MILLION DOLLAR QUESTION: HOW MUCH TO PAY FOR IT?

CHAPTER 14: THE MILLION DOLLAR QUESTION: HOW MUCH TO PAY FOR IT?

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Price-to-Book
Net Tangible Assets = Tangible Assets – Liabilities
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Price-to-Book

Price-to-book valuation involved comparing the market cap of the company with the book value of the company. Book value refers to the Net Tangible Asset (“NTA”) of the company. NTA is the net asset of the company, i.e. assets minus liabilities, but only taking into consideration tangible assets (which means non-tangible assets such as goodwill, as excluded in the calculation).

Net Tangible Assets = Tangible Assets – Liabilities

Price-to-Book valuation is commonly used in the following situations:

1. Valuing property development companies with significant land banks;
2. Valuing banks and financial institutions; and
3. Company going for liquidation.

In my view, the most applicable usage for this valuation method would be for point [2] and [3]. The reason is that property development tends to trade at a discount to book value, considering the development of the land banks is a long-term process. Not to mention assets are not easily converted to cash without losing its carrying value. Only property companies with a good track record of monetising its land banks will trade very close to its book value.

For banks and financial institutions, since their assets are either investments, loans, or cash and cash equivalents, which can be liquidated at either its carrying value or close to its carrying value, then book value would be a good indicator of the value of the company.

Price-to-Book valuation is also suitable for circumstances where companies have value that is hidden or not being well noticed by investors. Take Tomei Consolidated Bhd (“Tomei”) as an example. Table 7 below shows details of Tomei’s inventories extracted from Tomei’s 2016 annual report, page 78 under Note No. 9.

Table 7: Tomei’s Inventories – Extracted from 2016 Annual Report (in RM ‘000)
At Costs	2015	2016
Gold ornaments	143,375	159,332
Silver	–	338
Jewellery	178,604	169,081
Skin care products	1,883	1,881
Consumables	1,880	2,766
	325,742	333,398
At Net Realisable Value
Gold ornaments	9,648	–
Silver	1,944	1,543
	337,334	334,941

As can be seen from the table, the bulk of Tomei’s inventories are carried at cost, determined on a weighted average basis (as disclosed in Note 78(a) on the same page). Unlike other types of inventories, gold and jewellery inventories can be liquidated into gold. In this particular case, one can take the value of the inventories less all liabilities that Tomei has (which we can define as intrinsic value) and compare it with the market capitalisation of the company. If the market capitalisation is significantly lower than the intrinsic value, then Tomei can be considered as undervalued. This approach also provides investors with a reasonable margin of safety, as cash and the value of fixed assets have yet to be taken into consideration.

You must exercise caution if you wish to use this approach – the company must be profitable. Continuous losses will eventually erode the value of the company, and thus decrease the intrinsic value of the company.

This approach is similar to Benjamin Graham’s style of cigar-butt investing. The analogy is that there are cigars that are being discarded although they still have one last puff to go. Cigar-butt investing involves searching for these cigars which are deemed to be no value, taking it, and getting the last pouf out of it. The point to stress here is that this is just an analogy, and NOT an encouragement to pick up cigar butts and smoke.

However, this approach requires a lot of patience, as value may not be uncovered immediately.

This concludes Chapter 14. Chapter 15 will discuss on When to Buy.

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