One of my favourite metrics for finding value on the ASX is the price-to-book-value.
The price to book value is the comparison between the current share price and the current book value per share, also called equity per share.
The book value per share or equity per share, is the amount of equity on the balance sheet divided by the number of common shares.
Why is book value so important?
Book value is one way to measure the value of a company. Put simply, you add up the carrying value of the company’s assets, and subtract its liabilities, what you’re left with is the book value.
Compare that to the value the stock market is giving to the business (the share price), and you may have a great value investing opportunity.
As a value investor, for me it’s a great starting point.
Where to find this information?
In terms of finding this information, let’s use Harvey Norman Holdings Limited (ASX: HVN) as an example.
To find the current share price for Harvey Norman, you can go to any number of sites, I like Google Finance. Here’s Harvey Norman’s current share price at $4.06 on Google Finance:
To calculate the book value per share, first we need to figure out how many shares the company has outstanding. To do this, we go to Harvey Norman’s 2015 Annual Report and you’ll see the total number of ‘shares on issue’ as of June 2015 is 1,110,603,911 shares:
Then to find the equity number, we go to Harvey Norman’s Statement of Financial Position or Balance Sheet and look for the ‘Parent Entity Interests’, which is $2,537 million:
Now, all you have to do is divide the ‘Parent Entity Interests’ by the total number of shares ($2,537 million/1,110,603,911) and you get $2.28 of book value or equity per share.
To calculate the price to book value, we divide the share price ($4.06) by the book value or equity per share ($2.28) and you get a price to book value ratio of 1.78. The closer the book value per share is to the share price, the better the value.
That’s it! But how do we know how healthy they are?
Now that we’ve found our cheap stocks, the next step is to identify the healthiest companies. To do this I use something called The Piotroski F-Score.
The Piotroski F-Score was developed by a guy called Joseph Piotroski who is now associate professor of accounting at the Stanford University Graduate School of Business.
He developed a scoring system that essentially looks for companies that are profit-making, have improving margins, don’t employ any accounting tricks and have strengthening balance sheets. He uses nine scorecard variables, split into three groups:
Each test scores 1 point if the stock passes, or 0 otherwise.
1. Net Income. Positive net income (from the most recent financial statement) scores 1
2. Operating cash flow. This is a measure of profitability. Positive values score 1
3. Return on assets. This is the net profit divided by the assets. If the return on assets has increased year-on-year, then score 1
4. Earnings quality. If the operating cash flow is greater than net income, score 1
Leverage &Liquidity (i.e. Capital Structure and Debt Service)
5. Decrease in liquidity. If the long term debt divided by the average assets is lower this year than the prior year, then score 1
6. Increase in liquidity. The Current Ratio is the current assets divided by the current liabilities. If this year’s figure is greater than last year, score 1
7. Absence of dilution. If no new shares were issued in most recent year, then score 1
8. Gross Margin. Has the competitive position improved? If gross margin this year is greater than last year, then score 1
9. Asset Turnover. If asset turnover this year is greater than asset turnover last year, then score 1
What does all that mean?
It means that you can compare the health of companies on a like for like basis using the F-Score.
This score, out of 9, tells us what sort of financial shape the company is in. The higher the score, the better. Companies are scored as follows:
- Good or high score = 7, 8, 9
- Average score = 4, 5, 6
- Bad or low score = 0, 1, 2, 3
So how does this apply to our ASX companies?
Well, I started looking for ASX companies with a market cap greater than $13 Billion. Then I looked at their price to book value, and finally their Piotroski F-Score.
Here’s a list of the top 20 (22 actually) ASX stocks listed with a market cap greater than $13 billion. Companies are listed in Price to Book order, or cheapest to most expensive, and I’ve added their Piotroski F-Score, which is a indication of their healthiness. Ideally, we’re looking for companies with a low price to book ratio and a high Piotroski F-Score.
Obviously, further investigation would need to be done before buying these companies, but it’s a great starting point: