Warren Buffett and Ben Graham are the leading proponents of value investing, and no fundamental analysis metric has a greater correlation to the company’s value than the price to book ratio, and to a great extent, the price to tangible book ratio.
As value investors, we are more concerned with the value of a company, and more importantly, the book value of its assets than the earnings that Wall Street focuses the majority of its time on.
Understanding the book value of a company, and how that company uses those assets to create value for the shareholders is at the heartbeat of investing. A fantastic way to determine that value is the price to tangible book value.
In 2019, in the annual Letter to Shareholders, Buffett announced that his use of book value as a measure of value for his company Berkshire Hathaway no longer had the same meaning it did years ago, and he would no longer use that as a metric to value his company.
Wall Street, of course, jumped on that and claimed that book value was dead. Naturally, this was wrong, Buffett was simply, referring to how he looked at his own company and how his assets had changed over time.
Throughout this post, we will see that book value and specifically tangible book value are very much alive and can be a great tool to help you value a company’s assets.
In this post, we will discuss:
- What is Tangible Book Value?
- What is the Difference Between Book Value and Tangible Book Value?
- How to Calculate Tangible Book Value with Real Companies
- How to Use Tangible Book Value to Value Companies
Ok, enough preamble, let’s dive in.
What is Price to Tangible Book?
So what is a price to tangible book? According to Investopedia:
“The price to tangible book value (PTBV) is a valuation ratio expressing the price of a security compared to its hard, or tangible, book value as reported in the company’s balance sheet. The tangible book value number is equal to the company’s total book value less than the value of any intangible assets. Intangible assets can be such items as patents, intellectual property, and goodwill.”
The easiest way to think about tangible book value per share is to remember that the number represents the amount of money we investors would receive if the company would stop functioning and liquidate all of its assets at the value it has recorded on its balance sheet.
Generally, if a stock trades at a higher multiple of price to tangible book per share, it has the potential to leave investors with greater losses per share than companies that trade at a lower ratio. This is because the tangible book value per share should be reasonably be considered the lowest price at which stock should trade.
In 2011, Buffett stated in one of his annual letters that he would consider buying back any Berkshire stock when the company fell below 1.1 times its book value. That indicates that he feels that the company would be undervalued as its share price fell below the book value of its assets. I think that is a great case in point for the above point.
Price to tangible book value is a valuable metric, but it is not for every company. Notice above in the explanation of what encompasses the formula, such items as goodwill and intangible assets.
The ratio is far better suited to companies that have hard assets such as industrials, banks, insurance companies, and retailers. Price to tangible book value is not useful in the tech world, as most of the assets are intellectual property, which is near impossible to value, more on this in a little bit.
What is the Difference Between Book Value and Tangible Book Value?
When thinking of the differences between book value and tangible book value, think of book value as a more broad overview of the value of a company’s assets.
Where tangible book value is a more focused version of that metric, it strips out items such as goodwill, intangible assets because these items can’t be sold at auction.
Book value is thought of as the value of assets, and hard assets are items that you can sell and receive cash for them.
A good example would be if you owned a company that publishes books that you write. Let’s say as you go along with your company, things are going great, and you write several successful novels, and you print those books as well.
The money you pay for the printing presses, ink, paper, and other items for physically printing the books are hard assets. Where the ideas, characters, and plots that capture the public’s imagination are more intangible.
And what if your books suddenly fell out of favor and you had to sell your company to pay off your debts? The hard assets of the printing press, paper, ink, and other items related to the printing would have value at a sale, where your plots, main character, or creative ideas would be much harder to place any value for sale.
Price to tangible book value would allow you to place a monetary value on your printing assets, where book value would allow you to place a monetary value on your overall business.
Ok, let’s look at how we can calculate the price to tangible book value with a few companies.
How to Calculate Tangible Book Value with Real Companies
Before we look at a couple of examples, let’s outline what the price to tangible book value calculation looks like.
The formula for Price to Tangible Book Value:
P/TBV = Current Market Price / Tangible Book Value Per Share
Let’s break that down a little more.
Now, the current market price is one we can gather from any financial website. But finding the tangible book value per share will require a little sleuthing on our part, not hard sleuthing mind you.
We have a choice of looking at the ratio either with annual numbers or if you want a more up to date ratio, you can use the quarterly numbers. I will look at two examples, and we will use both methods to give you an example of how this can work.
Ok, let’s break apart the tangible book value per share a little.
Tangible book value per share = Total Shareholders Equity – Preferred Stock – Intangible Assets / Shares Outstanding
Luckily, this formula concentrates on the balance sheet, so there won’t be a lot of digging around other financial statements to find our data.
The first company I would like to dissect is Wells Fargo (WFC). Wells Fargo currently has a market cap of $100.7B, and a current market price of $24.58.
The first thing we need to do is look at Wells Fargo’s balance sheet to find our data.
Before we go, let’s discuss the intangible assets a moment. Intangible assets are items that have no hard monetary value and not always listed bunched together, so we might need to put on our Sherlock Holmes hat to find. Luckily Wells Fargo lays it out in the notes section for us, what they consider part of intangible assets.
From the balance sheet, we can gather:
- Shareholders equity – $182,718
- Preferred Stock – $21,347
And from the intangible assets notes, we can gather our information to determine what constitutes intangible assets, according to Wells Fargo.
- Total amortized intangible assets – $1,805
- MSRs – $8,126
- Goodwill – $26,381
- Trademark – $14
If we total all those items up, we get a value of $36,312 for intangible assets.
Again, items that are considered intangible are:
- MSR – which refers to amortization or fair value assumptions of mortgage loans. In Wells Fargo’s case, they are the largest mortgage lender in the US, and amortization is an intangible asset.
Now that we have determined all the inputs for our formula, let’s plug them all in and calculate.
- Current Price = $24.58
- Shareholders Equity – $182,718
- Preferred Stock – $21,347
- Intangible Assets – $36,312
- Shares Outstanding – 4135.3
P/TBV = $24.58 /( ( $182,718 – $21,347 – $36,312 ) / 4135.3 ))
P/TBV = $24.58 / $30.24
P/TBV = 0.81
Ok, that was pretty cool and not too hard, hopefully.
Let’s tackle another, shall we?
Next up, Prudential Financial (PRU) is an insurance company specializing in annuities and retirement products. Prudential currently has a market price of $56.77 and a market cap of $22.42B.
For Prudential, we will look at the annual numbers to calculate our price to tangible book value.
Pulling the annual numbers together:
- Price ending 2019 – $93.74
- Shares Outstanding – 410.8
- Shareholders Equity – $63,115
- Preferred Stock – 0
- Intangible Assets – $3,613
- Goodwill – $3,013
- Amortization – $600
Now we can plug all the numbers into the formula.
P/TBV = $93.94 / (( $63,115 – $0 – $3,613) / 410.8 )
P/TBV = $93.94 / $144.84
P/TBV = 0.65
Ok, I think we are getting the hang of this. Now let’s take some of our calculations and do some analysis regarding valuation.
Using Tangible Book Value to Value Companies
Now that we have calculated the price to tangible book of a few companies let’s see how we can put this to use to value a company with this ratio.
There are several methods that we can use, but one note of caution. Whenever calculating intrinsic value, remember that these are just estimates, and we need to do our due diligence along with these calculations to determine if the investment is right for us.
The first would be to take a longer view of the historical outlook of the price to tangible book value per share. I would recommend at least ten quarters to give you a good view of how Prudential has performed.
PRU Tangible BV TVBPS Pru Price P/TBVPS
17Q3 $50,373 $118.16 $81.65 0.69x
Q4 $53,292 $126.11 $103.92 0.82x
18Q1 $51,830 $123.11 $106.68 0.87x
Q2 $48,232 $115.47 $108.14 0.94x
Q3 $46,725 $112.75 $106.32 0.94x
Q4 $47,672 $116.07 $114.98 0.99x
19Q1 $55,010 $135.06 $103.55 0.77x
Q2 $61,660 $153.00 $93.51 0.61x
Q3 $65,798 $165.20 $101.32 0.61x
Q4 $59,779 $149.90 $93.74 0.63x
Now that exercise can give us a range of P/TBVPS that we can find the median of over the last ten quarters. We can also see the trend upward of the tangible book value over the period, and the steady range of pricing.
The median of the price to tangible book value over the ten quarters is 0.795.
Now we can take that median range and multiply that by the tangible book value per share that we calculate for the present quarter, which would be $149.56.
Intrinsic Value = Tangible Book Value per Share * Price per Tangible Book Value per Share
Intrinsic Value = $149.56 * 0.795
Intrinsic Value = $118.90
That would tell us what the tangible book value of the assets for Prudential would be worth in the market. The current market price of Prudential is $56.77, which would indicate that Prudential is undervalued compared to the tangible book value of its assets.
If you wanted to shortcut the historical median, you could simply take the current tangible book value and multiply it by the price to tangible book value of the current quarter.
For Wells Fargo that would be:
- Current Tangible Book Value per Share – $30.24
- Current Price to Tangible Book Value – 0.81
Intrinsic Value = $30.24 * 0.81
Intrinsic Value = $24.49
With Wells Fargo’s current market price of $24.50, it appears that the company is fairly priced according to the value of its tangible book value.
The other valuation opportunity with multiple is the theory of multiple expansion.
For example, in our examples of Wells Fargo, that currently has a price to tangible book value of 0.81 and that the median for Wells Fargo is 2.36.
Then you could simply multiply the current tangible book value price of $30.24 by $2.36 and arrive at what the price would be for Wells Fargo under “normal” market conditions for the bank.
The price of that calculation would be $71.36, which was below the range Wells Fargo was trading at before the Coronavirus pandemic hit the world. When using ratios like this it is good to look at a range of values and decide which you think is more reasonable.
Using that type of valuation is very simple and is a quick way to see if the company is trading at a discount and might warrant further study. In the case of Wells Fargo, the company has undergone some wounds of its own making, as well as the market taking a beating in regards to financials. All these ideas play in our minds when valuing a company.
Both of these valuation techniques are simple and easy to execute, don’t require a lot of higher math, and can get you in the ball park.
Always remember what Warren and Charlie like to tell us, it is better to be approximately right than precisely wrong. Valuation is an art and a science and doesn’t get caught up in finding that perfect number, rather use these tools as a means to end. It is finding the perfect investment for you and your risk appetite.
As we have seen, a company’s book value and tangible book per share don’t always reflect its true value. The assets may be on the balance sheets, but the book value includes items such as goodwill, amortization, and intangibles, which are difficult to assign a dollar amount. Book value may underestimate the true economic values of the assets. Still, it also may over-estimate their true economic value because the assets can become obsolete such as real estate.
For financial companies such as banks, insurance companies, and investment banks their assets are typically reported in the current market value of the assets owned, such as loans or insurance premiums.
Generally, book values of financial companies are a more accurate indicator of the economic value of the company, and tangible book values an even more true indicator of the company’s value.
Well, that is going to wrap up our discussion on the price to tangible book value. I hope you found something of value in this post, and thank you as always for taking the time to read it.
If you have any questions or if I can be of any further assistance, please don’t hesitate to reach out.
Until next time.
Take care and be safe out there,