VALUE INVESTING
King Of The Value Ratios

By Stephen Bland (TMFPyad)
December 9, 2005

Readers will be familiar with the four value criteria I use to determine the safety features of a share, Acronymically pyad, these stand for P/E, Yield, Assets, Debt. For value players a share on a low P/E, high yield, high assets and no debt is likely to be attractive on the face of it. Such shares are pretty rare.

But do these features carry equal weight for me? No. So which is the most attractive?

Without any doubt in my view it is high tangible assets, price to tangible book less than one. The market value of the shares being less than the value of its tangible assets. I class this not merely as the King of Value ratios but the Emperor. No even that's not adequate. Running perilously close to exhausting my mental stock of superlatives, I'll call it the God.

A share on a sufficiently large discount to assets is frequently attractive for that fact alone, even if it is making losses. Such pure asset plays are their own outer because what can happen is that someone sooner or later someone decides that better use can be made of those assets which can be obtained at a good discount. The mechanism for doing so might be a bid or new management but the fact is that it is anomalous for assets to be available at a high discount to their value and that anomaly is very likely to be corrected at some stage, though it might take quite a time.

It could be argued that an unreasonably low P/E for example is also anomalous and ought to be corrected too. I would agree, it is part of the value approach. But a low P/E can very easily evaporate and is consequently nowhere near as reliable as P/TBV < 1. A company's forecast eps can go wrong, in practice his happens all too often especially with small caps. Then the value level low P/E into which you thought you had bought has in an instant disappeared, to be replaced by a higher one, possibly none at all if the company now expects losses. Frequently this will be accompanied by dividend cuts, blowing away two legs of the pyad safety net in one go.

But tangible assets cannot so easily be dissipated by the distorted language of directorspeak or the stroke of an analyst's forecast pen. If you bought a share on a low historical P/TBV of say 0.7 then even if profit forecasts that were originally attractive have been aborted, you'll likely still have that asset cover. It is because of its resilience to such overnight changes that I believe P/TBV to be the best of the value ratios.

Note that I am not claiming that asset valuations are cast in stone, nothing is with shares. It is just that many assets are far less volatile than profits and consequently P/TBV is a far more dependable ratio than forecast P/E. This is why I see it as the single most important value feature by far.

The nature of the assets is important here. Property, cash, liquid investments are the most attractive with property being probably the most common. Plant, machinery and stock are of much less importance as they will tend to be of reduced value in difficult circumstances, whilst property usually has an open market value independent of the company's business. Also property can sometimes be in the balance sheet at old valuations which can thereby offer hidden value to the shrewd investor.

As always though with value, extreme patience is required. This goes for the usual value plays exhibiting a range of value features as much as for pure asset plays where those assets are the sole value attraction of the shares. Years can pass before anything happens. But when the turn does come it is usually sudden and you can't really know in advance when it might wake up. Cheap assets are the greatest attraction for the value player.