By elmads

I have discussed in my previous blog the basics of the Price-to-Book Ratio, its importance as a quick guide and metric to linking a company’s stock price to its actual business equity value/net assets. How it could aid investors into giving a general insight whether if the company is a good buy or not in terms of its safeness, that even if the company goes into liquidation bankruptcy, our capital will still be able to return to us safe and sound. It is only one of the hundredths of metrics in the investing world, its purpose is to only serve as a guide. To see Part 1 of this blog just click on the link provided. “Relative Valuation – The Price-to-Book Ratio”

Tangible and Intangible Assets

Before we go into the formulas and computation, we first need to understand the word “Tangible & Intangibles”. As per Google Dictionary, Tangibles are the physical aspects of things (straightforward), while intangibles are things that cannot be touched because it does not have any physical presence. Intangibles are the digital things that some people deem valuable for them, the in game items we buy inside the gaming system are good examples of this. For instance, the Fortnite “skins”, players buy these items because it makes their in-game characters look fancy.

But wait there’s more, the increasing popularity of mobile games granted massive in flows of income for the companies involved with it. Below are the Top Grossing Mobile Games Worldwide for June 2021:

Intangibles are also assets of a company, which can be seen on their balance sheet. I’ve made a blog where I discuss about the basic information and parts of “The Balance sheet”. Due to technological advancements, intangible assets have been ballooning in some companies, notably corporations who are in the technology industry.

The three commonly known intangible assets of a company are the following;

1. Patents – These are the intellectual property that gives its owner the legal rights to inhibit others from making, copying, using and selling their invention. Patents have a set period of time, once it expires then it will be free to everyone else to use, copy and sell. One example of patents are the drugs invented by pharmaceutical companies.
2. Copyrights – These are people or group of individuals who have the legal rights to copy and reproduce an inventor’s work. This means that the original creator agreed for his main invention to be copied and used by an exclusive person. Copyrights are widely used in the music and film industries. Like patents, copyrights protection also expires.
3. Trademark – is a symbol, phrase, word, or logo that denotes a specific product and legally differentiates it from other products in the market. For example the Apple logo, competitors will not be able to use that same logo for their company or business operations. Trademark expires, but can be renewed depending on the country where the main base of the business is located.

These 3 are the most popular types of intangibles, but there are others more like licensing agreement and website domain names.

Goodwill

Other than intangible assets, there’s also goodwill. Some consider goodwill as an intangible asset, which is somehow partially true because these are also non-physical assets that cannot be touched. Nonetheless, other companies separate this category on their company balance sheet.

Intangible assets are identifiable, goodwill are hard to find and truly quantify. Accountants have their own way of doing their accounting stuff in Goodwill, but mostly what it captures is the customer loyalty, brand reputation, and other non-quantifiable asset count.

Goodwill are mostly considered in Mergers and Acquisitions of another company. Companies who acquire another company pay for the selling company’s goodwill, as it is the premium being paid for the fair value of a company. Based from investopedia.com, Goodwill is the value of a company’s brand name, solid customer base, good customer relations, good employee relations, and proprietary technology represent some reasons why goodwill exists. Put it simply, the established reputation of a business regarded as a quantifiable asset and calculated as part of its value when it is sold.

Goodwill & Intangible Assets

Now both have been defined, the question is, what is then the relevance of the Price-to-Tangible Book Ratio? These two help investors into finding the true value of a company’s physical assets by removing the Intangible Assets and the Goodwill of the company.

The total Equity of the company will decrease when we remove these two, but we have to understand that Goodwill & Intangible assets are not physical assets at all. They do not hold strong value and do not help to generate additional income for the company, unlike their property, plant, equipment, cash, and inventory.

There is a term in investing called the Watered Stocks. These are companies that have good Equity thanks to the inflated Goodwill and Intangible Assets. Both of these two, most especially the Goodwill, are not 100% quantifiable, which can mislead investors to perceive that the company has a healthy balance sheet.

Just like what Professor Aswath Damodaran said, Goodwill are plugs used by some accountants just to balance the balance sheet. Only few investors will always question the amount of Goodwill, and see if it is right or wrong.

This is the main reason why Price-to-tangible Book is used by some investors. Nevertheless, it is not always applicable to use this metric in all industries. See for example the technology companies like the Big Tech in the US. Most of their Assets are intangibles, such as software and operating systems. These are intangible assets that are working for them to generate income for the business, because their services such as cloud computing and storage are one of their revenue drivers. Microsoft has their operating systems which is also a key provider of their revenue. Knowing how the company and its industry operates and makes money are the key determinants if using PTB ratio is essential or PB ratio will just do fine.

Price-To-Tangible Book Ratio

We now move forward to PTB Ratio. The computation starts with various steps. As an example I’ll be using Bank of America’s 2020 Balance Sheet.

First Step: we need to locate the Shareholder’s Equity of the company then the Intangible Assets & Goodwill

Note: Some companies merge Goodwill with Intangible assets. This means that there is no Goodwill portion or Intangible Assets, its either one of the two that they will only show in the balance sheet.

Shareholder’s Equity = 272,924 Billions USD

Goodwill = 68,951 Billions USD

Tangible Shareholder’s Equity = Shareholder’s Equity – Goodwill

  = 272,924 – 68,951

Tangible Equity = 203,973 Billions USD

Second step: compute for the Tangible Book Value per share, by dividing the Tangible Equity to the company’s total shares outstanding

Tangible Equity = 203,973 Billions USD

Total Shares Outstanding = 8,796.90 (this is located in Bank of America’s most recent Income statement.)

Tangible Book Value per Share = 203,973 / 8,796.90

TBVS = 23.17

Third step: get the Price-to-Tangible-Book Ratio. It is by dividing the current market price to its Tangible Book Value per Share (TBVS).

As of this writing 03/08/2021, Bank of America’s Stock price is $37.96 per share.

by doing the formula;

Price-to-Tangible-Book = Stock Market Price / Tangible Book Value per Share

  = $37.96 / 23.17

PTB Ratio = 1.63

Fourth step: interpret and understand the number behind the ratio. We also use the chart of safeness ratio for PTB Ratio as what we use with PB Ratio too. See chart below.

SAFENESS CHART

As per the capital safeness chart, the lower the ratio is, the more secured our capital when company liquidates their assets. This is in my own opinion the best option to take rather than the Price to Book Ratio. If liquidation actually does happen, Goodwill and Intangible assets are sometimes not considered anymore to be of an asset that can be liquidated to cash, unlike the tangible assets that the company has.

One way also to grasp and understand the Price to Tangible Book Value is by comparing it to the company’s own historical PTB Ratio. Below is the Historical 10 year PTB Ratio of Bank of America.

I got the information from https://tikr.com/, which is where I get some of the information of company’s financial statements.

PER COMPANY’s HISTORICAL DATA

As you can See Bank of America these past 10 years has an average Price to Tangible Book ratio of 1.23, by these simple metric we could say that the current Price to Tangible book ratio of 1.63 is higher than its 10 years average.

PER INDUSTRY

Also, we could use PTB ratio to compare it to other companies within their industry. This is to help understand if Bank of America’s PTB ratio is higher, or on average or lower than other banking companies in the US.

As per the data comparison, we could say that Bank of America’s PTB Ratio is a bit above or within the average of other bank’s PTB ratio.

To sum it up

Price-to-Tangible Book Ratio is applicable for mainly industrial or capital intensive industries, who own a high proportion of hard assets like property, land, equipment, cash and cash equivalents, and inventory. Using PTB Ratio gives us with a nearer accurate value of the company’s health and overall net assets.

On the other hand, PTB Ratios are not relevant for companies with high intellectual assets (the intangible assets & goodwill) and also service oriented industries. One of the best examples is the Technology industry due to their subscription based services and intangible software, data and operating system assets.

Price to Book and Price To Intangible Book ratios had their peak popularity during the 20th century, but times have changed already. This is due to the changes in our world, with the further improvements of technologies, companies moving into the digital realm which further increases the intangible aspects of their assets. This in turn also affects investors, on how they should see and value the importance of these changes in their investment thesis. Intangible assets are starting to dominate companies, this is why newer metrics have been emerging to give it more clarity.

Relative valuations are not the primary indicators into making an investment decision. It is only one of the diagnostic examinations that support one’s investment assumptions.

Just like in the medical field, a doctor will not be able to arrive into a near accurate diagnosis of a disease and/or illness without the proper assessment, and support of various diagnostic examinations.

Knowledge is my Sword and Patience is my Shield,

elmads

This blog is for informational purposes only and not a Financial Recommendation. Not all information will be accurate. Consult an independent financial professional before making any major financial decisions.