Book Value

Book value gets a lot of attention these days-perhaps because it's such an easy number to find. You see it reported everywhere. People invest in these on the theory that if the book value is $20 a share and the stock sells for $10, they're getting something for half price.

The flaw is that the stated book value often bears little relationship to the actual worth of the company. It often understates or overstates reality by a large margin.

A textile company may have a warehouse full of fabric that nobody wants, carried on the books at $4 a yard. In reality, they couldn't give the stuff away for 10 cents. There's another unwritten rule here: "The closer you get to finished product, the less predictable the resale value". You know how much cotton is worth, but who can be sure about an orange cotton shirt? You know what you can get for a bar of metal, but what is it worth as a floor lamp?

Overvalued assets mentioned in balance sheet are especially treacherous when there's a lot of debt. Let's say that a company shows $400 million in assets and $300 million in debts, resulting in a positive book value of $100 million. You know that debt part is a real number. But if the $400 million in assets will bring only $200 million in a bankruptcy sale, then the actual is a negative $100 million. The company is less than worthless.

When you buy a stock for its book value, you have to have a detailed understanding of what those values really are.