Quarter of Belgian shares are below book value

One in four Belgian stocks is below their book value. Although the ratio has lost its popularity in recent years to value stocks, it offers guidance in difficult times and a long-term comparison may indicate buying opportunities in some sectors.

Accounting is one of the least popular parts of the business of economics for many, but it is essential for investors to get a good idea of a company. Perhaps you have supplanted school knowledge, hence some theory first. The book value is the company's own funds. You can find it in the balance sheet on the liabilities side, which shows where a company gets its funds from. It consists broadly of the capital raised by the shareholders at the time of incorporation and through subsequent capital increases, the accumulated legal reserves and the profits transferred. If a company does not distribute its full profit, its book value increases. If there is a loss, it is deducted from the book value. A capital reduction also eats away at equity.

According to many handbooks, the book value is a lower limit for a healthy company. These are companies that get more returns than the costs they have to incur to borrow money. Many also see it as a measure of value. Because equity is invested in various assets, such as buildings, land, stocks or licenses, it provides an overview of a company's assets.

Destroy or create value?

With stocks that are below their book value, investors theoretically assume that they will destroy value for their shareholders in the long term, rather than create it. That is why many problem names in the list of stocks are below their book value. Examples include the debt-ridden carpet maker Balta BA, the shipping companies Euronav and Exmar, which suffer from low shipping rates, or the diaper manufacturer Ontex, which went into a lot of debt to take over a cat in a sack in Brazil.

The National Bank, which is trading far below the book value, is a special case. The dividend is low in relation to profit because a significant part of the profit is transferred to the state.

Two companies have a negative book value, so there is no price-book value to calculate. The maker of cooling towers and heat exchangers Hamon has accumulated huge losses and only survives by the grace of its main shareholder: the Walloon government. He should make some extra money again this year.

Telenet is also struggling with negative equity, due to the generous dividends and capital reductions that flowed to shareholders. Nevertheless, that is no problem for the telecom group. The company records large cash flows. Thanks to the monthly subscriptions, Telenet is so sure of its income that the banks won't make a problem of the weak balance sheet, as long as customers don't walk, of course. The main shareholder Liberty Media has played the game brilliantly and has since gotten much more out of the company than ever before.

The higher the return on equity, the higher the price-book value may be.
- Patrick Millecam

Cyclical companies

“Telenet is a perfect example of why book value often offers little guidance for valuing a company,” says Geert Smet, deputy editor of De Belegger magazine. “The book value itself doesn't mean much, although long-term evolution may provide an indication of performance or valuation. Especially for smaller stocks or cyclical companies, it can be an indicator. At the steel cord maker Bekaert, a low price-book value has always indicated a buying opportunity in the past. ' At more than 1.5 times the book value, Bekaert currently seems to be fairly valued.

“We also make hardly any use of book value in our models,” says Patrick Millecam, partner and chief strategist at asset manager Value Square. “We value companies based on their profit potential. For certain cyclical sectors, such as commodity companies, shipping or a steelmaker such as ArcelorMittal, the book value can be interesting as a point of comparison in a long-term perspective. It is often better to invest in those sectors when the outlook is poor and losses are made. '

Debts

Just looking at the book value as an investor is therefore pointless. The ratio says nothing about debt and profitability. Let's take Vranken-Pommery as an example. The world's largest champagne maker after LVMH doesn't even list half its book value of 41 euros. According to that ratio, this is very cheap and points to the group's many assets such as vineyards and castles. But Vranken also has a sky-high debt of 684 million euros. Even in a corona-free year, most of the company's profit flows into interest payments. Banks and bondholders benefit, shareholders less. Vranken is trading at 73 times its profit, which, according to that ratio, is very expensive.

Smet does point out that book value can be useful in times when companies suddenly see their income decimated, such as during the corona outbreak. Amusement parks, movie theater operators, fitness chains and hotels suddenly saw their cash flows disappear. “The balance is then very important to know who can survive,” says Smet. “You can compare the book value against debts. High debts with low equity make a company vulnerable if something goes wrong. Investors don't like that. '

In the pandemic year, one out of three Belgian companies saw their equity fall, while in a normal year, that figure is only one in four. It is one of the reasons why the number of companies that are below book value has risen from 15 to 26 percent of the price board in ten years.

Goodwill

A major problem with book value is the valuation of goodwill. This is the part that a company puts more on the table in the event of a takeover than the prey's own funds. If the activities of the acquired company do not meet expectations, the acquirer will have to write off goodwill, causing the equity to fall. Last year, for example, the chemical group Solvay booked 1.5 billion euros, which roughly corresponded to the goodwill it paid for the acquisition of American lightweight composite maker Cytec in 2015. Due to the standstill in aviation, that branch is running a lot less turnover and profit.

“In the IFRS international accounting standards, companies must do tests to justify goodwill on the balance sheet and, if necessary, write it off. These tests do leave the companies with the necessary flexibility,” says Smet. 'I have the impression that before IFRS, goodwill was written off more quickly. '

It is remarkable how quickly book value has lost popularity among investors in a few years. Even superguru Warren Buffett has not mentioned the book value of his holding company Berkshire Hathaway since 2019, even though he has done so systematically since 1964. He states that the book value underestimates the actual value. In addition, Berkshire's major holdings are unlisted. In any case, the intrinsic value is a better indicator for holdings.

What Works on Wall Street

“Author James O'Shaughnessy has proven in his standard work “What Works on Wall Street” that investing in the cheapest companies based on their price-book value was a good strategy in the very long term, but this has been much less the case in the past ten to twenty years,” says Millecam. Much of the explanation lies in the success of the technology companies, which are achieving phenomenal profit growth with relatively small equity.

“The best ratio for finding low-cost companies is now to compare entrepreneurial value (market value + debt) to gross operating profit, so-called EV/EBITDA,” says Millecam. This ratio also takes into account debt and profitability, which the price-book value says nothing about.

“There is still a clear relationship between a company's return on equity (ROE) and its price-book value. The higher the ROE, the higher the price-book value may be,” says Millecam. It explains why thriving growth companies such as chipmaker Melexis, cookie baker Lotus Bakeries, or e-commerce company Smartphoto are well above their book value, but turned out to be far from bad investments.

DISCLAIMER

• Source: Time
• Author: Serge Mampaey
• Link: https://www.tijd.be/markten-live/homepage/kwart-van-belgische-aandelen-bengelt-onder-boekwaarde/10306147.html?