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Unlike the Hokey Cokey, buying shares when they trade below their intrinsic value is what investing is all about. But if it was as simple as this, investing would be a lot easier than it actually is.
A company’s book value – the difference between what it owns and what it owes – can give some idea of what a stock’s worth. And a few FTSE 100 shares look cheap on this basis.
Barclays
Barclays (LSE:BARC) is one example. At a price-to-book (P/B) multiple of 0.69, the company could in theory sell off everything, pay down its debts, and give investors £1 back for every 69p they invested.
That’s nice in theory, but not only is the bank not doing this, it’s doing the opposite and attempting to expand its US credit card business. So investors thinking about buying the stock need a better thesis.
It’s not hard to find one. Barclays is trading at a lower P/B multiple than Lloyds Banking Group (0.87) or NatWest (1.00), indicating the market doesn’t think it can use its assets as efficiently as its rivals.
That might be a mistake. Unlike the other UK banks, Barclays has a big investment banking division and this should benefit if the Bank of England gets back to cutting interest rates – as I think they will.
One of the risks with the stock is the possibility of shifting banking regulations. No less than billionaire investor Warren Buffett cited this as a key reason for selling US banks and it’s something the firm has no control over.
Despite this, the relative discount to other FTSE 100 banks makes Barclays shares interesting and worth further research. And this is certainly a better thesis than hoping a low P/B multiple means a quick return might be on the cards.
Vodafone
Like Barclays, Vodafone (LSE:VOD) trades at a discount to its book value. The current share price implies a P/B multiple of 0.34 – the lowest in the FTSE 100. Investors should note though, that the telecoms company’s balance sheet isn’t so straightforward. On the asset side, it has a significant amount of goodwill, which is an intangible asset.
Goodwill appears on a company’s balance sheet when it makes acquisitions. But if the value of those investments changes over time, the associated goodwill tends to evaporate into thin air.
I think investors would therefore be wise to discount this from their thinking when it comes to Vodafone’s assets. Even so, the stock’s still well below the company’s book value.
Importantly, the firm (unlike Barclays) has been looking to take advantage of this. It has sold off its Spanish and Italian units and returned some of the proceeds to shareholders via buybacks. I think this has clearly been a better use of capital than its huge investment in 3G licenses, but CEO Margherita Della Valle has ruled out further divestitures. With that being the case, I don’t have a reason for wanting to buy the stock.
Valuation
Buying shares for less than they’re worth is great and can give value investors a nice warm feeling inside. But it can be a long time before the returns show up. Unless something happens to close the gap between price and value, stocks can trade below the book value of the underlying business for a long time.
That’s something for investors to remember.
