Acing The Book-Value Test

Duke Energy, Allstate, Dow Ace Book-Value Test

By John Dorfman | 13 April 2009

April 13 (Bloomberg)— With a nasty recession raging, 20 percent of all U.S. stocks with a market value of $250 million or more are selling below book value. This group includes household names such as Duke Energy Corp., Allstate Corp., Dow Chemical Co. and Time Warner Inc. Book value is corporate net worth, usually expressed per share of common stock. Coca-Cola Co., for example, has $40.5 billion in assets and $20 billion in liabilities, for a net worth of $20.5 billion. Divide that figure by Coke’s 2.3 billion shares outstanding, and you have $8.85 as the company’s net worth per share, also known as book value or stockholders’ equity. With its shares trading at $44.99, Coca-Cola sells for more than five times book, a ratio I would consider expensive even when the stock market is booming. In normal times I want a price-to-book ratio below two. These days, I look for ratios below 1.5, and prefer those below one.

Some people dismiss book value as a measure of intrinsic worth, saying that it is distorted by accounting conventions. Let them scoff. The fewer investors using this tool, the better it is for those of us who do. Certainly some accounting practices do create distortions.

Oil companies, for example, frequently carry promising properties on their books for far less than their true worth. On the other hand, a technology company with an inventory of aging modems may carry them on its books for a sum greater than their true worth. Yet in my opinion these anomalies are rare, and often relatively small.

Here are five stocks selling below book value that I think qualify as bargains.

Duke Energy, based in Charlotte, North Carolina, is an electric utility that mainly serves the U.S. Southeast and Midwest. It also operates in Latin America. I like Duke because it is a leader in nuclear power and has a handsome dividend yield of more than 6 percent that looks reasonably secure. For a utility, its debt load is slender, at 41 percent of total capital. Duke shares are selling for only 0.9 times book value and 11 times earnings.

Allstate, based in Northbrook, Illinois, is the largest publicly traded auto and home insurer in the U.S. (Its biggest competitor, State Farm Mutual Automobile Insurance Co., doesn’t sell stock.) Allstate’s stock is at about $23, down from $65 at the end of 2006. At today’s price it trades for seven times earnings and just under book value. I think it has good appreciation potential from this level, plus a dividend yield of more than 3 percent that appears pretty secure.

Time Warner has a constellation of media assets, including Time, Fortune, People and Sports Illustrated magazines; Warner Brothers and New Line Cinema movie studios; the AOL internet portal; and cable television channels HBO, Cinemax, Cartoon Network, TBS and TNT. There are obvious synergies among these properties, but New York-based Time Warner hasn’t effectively exploited them. Indeed, I look at it another way: This collection of media properties is a tangerine, pieces of which can profitably be spun off or sold. Earnings in the fourth quarter dropped to 69 cents a share from 99 cents a year earlier. The stock is priced on the assumption that Time Warner will continue to struggle. It sells for only seven times earnings and 0.6 times book value.

Dow Chemical, with headquarters in Midland, Michigan, is a stock I shied away from for a long time. I thought that it produced too many commodity chemicals with thin profit margins and that high oil prices would crimp its profits. And lately I fretted about the debt it would need to finance its off-again, on-again acquisition of Rohm & Haas Co. The situation has changed. Oil prices have come down, reducing the company’s raw-material costs.

Dow has announced the sale of Morton Salt, the largest salt maker in North America, to K+S AG, Europe’s largest salt producer, for $1.67 billion. The move gives me some faith that Dow’s management will sell assets to pare down debt. Most important, Dow’s stock has fallen to $10.94, from a peak of more than $55 in 2005. At six times earnings and 0.8 times book value, I find it attractive.

A more obscure stock I like in the below-book category is Seaboard Corp, a family-controlled company based in Merriam, Kansas. Seaboard engages in pig farming, grain milling and ocean shipping. If you are averse to volatility, Seaboard will give you heart failure. For example, it was down 33 percent in November 2008, then up 33 percent in December. But in the past five years its stock has risen 187 percent, and I believe it continues to have appreciation potential. Seaboard shares fetch nine times earnings and 0.9 times book.

Disclosure note: I own Time Warner and Seaboard for clients and personally. Some of my firm’s clients own Allstate. I do not currently have long or short positions in the other stocks discussed in this column.

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Normxxx    
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