Friday, January 21, 2011

3 Stock Bargains Based on Assets: ADM,ED, SJM


Thirty years ago the typical U.S. stock sold for less than a 20% premium to its "book value" – or what the company's accountants say its factories, machines, patents and other assets are worth. Today the typical stock sells for a premium of more than 150% to its book value.

Part of that difference is surely explained by the rise of the information economy. Companies like Google ( GOOG: 626.77, -4.98, -0.78% ) and eBay ( EBAY: 30.78, +1.68, +5.77% ) turn ideas into profits using only a sprinkling of physical assets. But it may also be due to over-pricing by investors. And stocks with low share prices relative to their book values tend to produce higher returns than those with high price-to-book ratios, all else held equal. That phenomenon has been documented since the early 1990s and as recently as 2006.

One theory on why stocks with low price-to-book ratios tend to outperform has to do with the tendency of investors to extrapolate past events too far into the future. Highly profitable firms tend to be awarded high price-to-book ratios, but also tend to attract a rush of competition that can crimp future earnings. Companies with modest price-to-book ratios, meanwhile, lend themselves well to the sort of efficiency efforts that can improve future returns. (more)

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