Question: I’ve heard that looking for stocks with a low book value is one way to make money. True?

A BuyAndHolder

Answer:

Dear BuyandHolder,

The answer is “maybe” and “sometimes.”

Let’s first define book value for those unfamiliar with the term. Book value is the net worth (or value) of a company. It’s basically an accounting term that refers to carrying value on the books.

You can find the book value for many stocks listed in Value Line Investment Survey or you can do the calculations yourself by looking at the a company’s balance sheet and then subtracting its liabilities from its assets. 

Basically, the term is interchangeable with shareholder’s equity in that it is the total value of the company’s assets that each and every shareholder would receive if the company were liquidated.

Book value, however, is not an exact measure of true value. This is particularly the case when it comes to real estate. If a company has owned property for some time, that property may have been partially or fully depreciated and thus not completely reflected on the balance sheet. In fact, if the property has been fully depreciated over the years, it would have zero value on the balance sheet. That means, obviously, that the company’s book value would be understated.

The same could be true for a company that’s written off heavy machinery and equipment.

In terms of your own research, if a stock is selling below book value, it might be a bargain. And/or it might be a candidate for a takeover. However, there is no guarantee that either will be the case.

And, keep in mind that selling at a discount to book value is not in and of itself a reason to purchase shares. You want to make certain of other issues as well: that the stock is performing better than others in the same industry; that it is not going to declare bankruptcy; that it is likely to survive and thrive; and that it is poised for a comeback that has not yet been recognized in the marketplace.