The cornerstone of value investing was the price-to-book ratio. Value investors would look at the assets a company owns and compare it to the price they have to pay per share. The dream was to find a company that owns $100 million of farmland and is trading for $50 million on the share market. Or a company that owns a $40 million factory and is trading for $30 million. The value of the assets was greater than the share price. Classic value investing. If everything went wrong, the company could sell its assets and the investor would still make money.
But that style of investing has gone out of favour as companies with intangible assets have started to dominate the stock market. Google, Microsoft and Facebook were examples of companies that didn’t need to own a lot to generate huge profits. Their assets were intangible – their people, their software, their networks. And so price-to-book ratio has fallen out of favour as a preferred investor metric.
And it isn’t just technology stocks that have pushed price-to-book out of the spotlight. Companies like Coca-Cola own plenty of assets, but their most value assets doesn’t show up as a tangible asset on their balance sheet – it is their brand. And that, once again, isn’t captured in the price-to-book calculation.
This article takes a look at modern day value investing and considers how the price-to-book ratio can still be relevant for the modern investor.
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