Are company stocks assets or equity

Price-to-book ratio

Very interesting:
P / E ratio
Profit margins
Enterprise Value
Cash flow
Return on investment In addition to the price / earnings ratio, the price / book value ratio (P / B) is also one of the most popular key figures for valuing stocks. The KBV also has the advantage of being easy to calculate. The calculation parameters can be easily read from the published figures of a company: The KBV is calculated from the quotient of market capitalization and equity.

You can also do the calculation per share. Although the price of the share is easy to find out, the equity per share must be calculated separately, as this is usually not included in company reports. The calculation on an overall basis is therefore generally preferred. Expressed in formulas, the calculation of the P / B is as follows:

In contrast to the price / earnings ratio, for example, the P / B is not a key figure for evaluating a company's profitability. Rather, the ratio between the stock market value, i.e. the market capitalization, and the intrinsic value, i.e. the equity, can be measured using the KBV. The KBV is therefore used to consider the intrinsic value.

The KBV is often seen as one of the most important metrics for value investors. The interpretation of the KBV makes it clear why. If a company's equity is greater than its market capitalization, a ratio of less than 1 is calculated.

This means that the company is not even allowed the value of its equity on the stock exchange. So if the equity can be considered valuable, a listing of the share below equity is not justified. Accordingly, a KBV less than 1 is considered favorable.

Let us assume that a company has assets of € 10 million that are made up entirely of cash, so they are definitely valuable. If there are additional debts of € 4 million, the equity amounts to € 6 million (assets - liabilities = equity). If, however, the share is quoted at a market capitalization of € 5 million, this results in a P / B of 0.83 (5 million market capitalization / 6 million equity). The stock is therefore undervalued by around 17%.

The reasoning is simple. If the owners decided to liquidate the company, after the debt was repaid, € 6 million would be left in the form of cash. So there would be more than if the owners were to sell their shares on the stock exchange, with only € 5 million being raised.

How much is the equity worth?

So much for the theoretical model calculation. Of course, in practice it is not the case that a company has assets in the form of cash only. In order to run the operative business, it is rather necessary to own very different assets, depending on the business model. These can include buildings, vehicles, machines, or computers. Inventories and receivables, for example from customers, are also assets that can be assigned a value.

Remember: Equity is calculated as the difference between the value of assets and liabilities. The difficulty lies in assessing the intrinsic value of the assets. This is where the biggest stumbling blocks lurk when considering KBV.

If the assets do not have the reported value, the equity is shown too high, which means that the calculated P / B ratio would also be too low. This would suggest a favorable evaluation for which the prerequisites are actually not given.

Accordingly, it is absolutely necessary to examine a company's assets. The range of assets is endless. We therefore focus on the most important assets that can most often cause problems.

Intangible assets

The biggest point of contention between analysts and investors are intangible assets such as goodwill, customer lists, patents and licenses or the like. Intangible assets are intangible and do not have an easily determinable market value. This applies in particular to goodwill.

Goodwill is the amount that a company pays in the context of a takeover of another company above its equity. Paying such excess amounts can make sense, for example because the takeover will result in synergies or strategic advantages. However, these advantages are not tangible and will only become apparent in the future, when income can actually be generated from them.

Because these intangible assets are subject to such uncertainties, some analysts and investors reduce equity by intangible assets, especially goodwill, before calculating the P / B. One can imagine that this can have a drastic impact on the P&B, especially when a company has a large amount of intangible assets.

This applies, for example, to holding companies that make many acquisitions or technology companies that have amassed a number of intangible assets as a result of their development activities. These companies would be wronged to simply reduce their equity capital by reducing their intangible assets. Unfortunately, there is no simple solution to this problem.

But if you want to be on the safe side, you usually reduce intangible assets. On the other hand, there is also no reason to assume that the intangible assets should not hold their value if a company operates profitably and generates good cash flows. A decrease in value is then not to be expected and a reduction in equity is therefore not necessary.

We believe that this pragmatic approach is preferable. Nevertheless, it is important to keep an eye on and question the intrinsic value of the intangible assets.

Current assets

Current assets must also be subject to constant consideration. In particular, it is important to examine accounts receivable and supplies. For example, if a company sells a product for which there are no longer any buyers on the market, the inventory may have to be devalued. This reduces the equity. The same applies to stored raw materials.

When a company needs copper for production, it maintains an inventory of copper. As soon as the copper prices fall, this must also be devalued. By constantly monitoring the prices, one can anticipate possible devaluations. A KBV of 1 can appear in a completely different light against such a background. The same applies to claims. If the claim is against a large customer, this could lead to a heavy burden on the company, as the claim would then have to be written off worthless. The equity is charged. It is therefore important to know a company's customer structure. If there is a cluster risk or if the customers are not very solvent, this must be closely monitored.

liabilities

While assets can be overvalued on the one hand, liabilities can be underestimated on the other. In most cases, this is not a problem with regard to loan liabilities, as these are known in terms of the deadline and due date.

As a rule, provisions in particular should be scrutinized. Imagine a company has planned some litigation provisions - but in the event of a negative outcome, the burden of a compensation payment would be significantly higher than anticipated. This would reduce the equity capital beyond the previous expectation, with an increasing effect on the KBV.

Another difficult topic is pension provisions, the calculation of which is subject to many variables. Changes in these factors can lead to decisive differences in the amount of pension provisions and change the amount of equity significantly.

Hidden reserves

On the other hand, when considering the KBV, not only the hidden burdens have to be taken into account, but also hidden reserves. If the fixed assets of a company are shown too low in the balance sheet, the P / B ratio is calculated too high.

In most cases, such hidden reserves are in real estate assets. For example, if a company has real estate assets that are not shown in the balance sheet at their true value, then the equity capital is also shown too low.

For a correct KBV assessment, a mathematical consideration of the true value of such a property must be made by increasing the equity capital by the hidden reserve. Again, this is not an easy undertaking, as determining the amount of the hidden reserve requires careful research and calculation.

Keep it simple

If you want to calculate exactly, you can make a variety of corrections and adjustments. Often, however, such a detailed analysis is not necessary, since the informative value of the KBV as such should not be overestimated anyway. Many companies that are trading below book value (market capitalization < eigenkapital="KBV">< 1),="" erwirtschaften="">

Losses in turn reduce the equity and thus the substance of a company. Accordingly, a note under book value does not have to be a sign of a favorable valuation. On the other hand, a high P / B, say of 3 or 4, does not mean that a company is to be assessed as bad. On the contrary, studies have shown that companies with a high P / B achieve even better returns than stocks with a low P / B.

What is the background of this? Why then carry out an examination of the KBV at all? This becomes clear if you look at the KBV from a different perspective. This can also be expressed as a function in relation to profitability:

From this context it becomes clear that the book value of a share is higher, the higher the net income and the return on equity of a company. Correspondingly, the P / B is also higher for highly profitable companies with high returns on equity. It becomes clear that evaluating a company based on its profitability is ultimately the most important consideration.

The KBV is well suited to identify possible undervaluations. But using the KBV is by no means a panacea. Rather, the KBV is also a function of profitability. This should be the main focus when evaluating a company.

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Author of the post "KBV: price book value ratio":
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