The price-to-book value of a company is very important to value investors. It was a major theme in Benjamin Graham's book the Intelligent Investor and it has been very important to Warren Buffett throughout his investing career. Buffett has stated repeatedly that his number one investment rule is to not lose money and that his #2 rule is to remember rule #1.
When considering the purchase of shares in a company, knowing the book value or underlying value, minus any "good will," gives you a foundation on which to place some confidence. The book value is not the same thing as the break-up value of a company, which might be more or less, but they do have a relationship. The most important thing about understanding the book value is to have some idea of what the company is worth in a "fire sale." What is the company worth in its lowest common denominator. Ideally you want to pay something less than, or close to a book value of 1.0. Stocks with very high P/B ratios imply many intangibles and a higher degree of speculation in the stock price.
I believe one of the unstated reasons Buffett prefers to stay away from tech stocks is that the book value is too hard to get a handle on. If a tech company goes out of business, its inventory may be worth pennies on the dollar and the same is true of its plant and equipment. If a brick company goes out of business, its plant and equipment are worth much more (the valuation is more reliable) in the open market, and the bricks are bricks are bricks without much loss of value. Unless, of course, there are other issues that make them inferior or the macro economy is affecting the price, but that would affect all bricks.
Sometimes one can also find value in examining the book value because some things like real estate, oil, or precious metals might be worth more than the stated book value and are not seen in current terms. This has spawned the expression "the cheapest place to find oil is on the floor of the New York Stock Exchange." If, as I expect, we see several acquisitions of oil companies in the next few years, this will be the reason, and there are many mid-size companies with considerable reserves that I think are under valued.
The following links are for the first two stories in the series: Serious Money: The page on Buffet t -- Part I: your understanding and Serious Money: The page on Buffett -- Part II: Dividends.
Those of you who are new to BloggingStocks can check out my other stories and read Chasing Value or Serious Money to find more potential opportunities and verify my track record, as well.
Sheldon Liber is the CEO of a small private investment company and the vice president for design and research at an architecture & planning firm. Check out his other posts for BloggingStocks here.
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