YOUR KILLER EQUITIES INTERVIEW QUESTIONS: Why might a stock trade below its book value?

29 July 2011

2 minute read

YOUR KILLER EQUITIES INTERVIEW QUESTIONS: Why might a stock trade below its book value?

Here's the latest in our series of killer equities interview questions sent in by members of the giant eFinancialCareers community. This was allegedly asked for an equity research role at Deutsche.

THE QUESTION: Why might a stock trade below its book value and should we always buy those stocks? Can you think of any examples right now?

THE ANSWER:

Since book value is an accounting term, there are various reasons why this may happen.

This situation can arise because of the way the assets are accounted for on the balance sheet. But it can also happen for very negative reasons. For example, the solvency of the organization might be in doubt, or the structural future prospects of the industry the firm is in might be bleak.

The quality of the assets and earning potential of the given firm must always be taken into account when buying stocks with low book values. Just because the price to book multiple is less than one, there is no guarantee that the stock price will rise.

At the time my friend was asked this, there were very few obvious groups of stocks trading below book value. This made the question difficult to answer. At present, however, there are plenty of obvious examples - particularly in the Japanese stock market.

The problems in Japan are primarily because the outlook for the economy is very poor given the high debt levels, declining savings rates and poor demographics. Even before the recent earthquake, something like 2/3 of the Nikkei 225 stocks were trading below book value.

AUTHORSarah Butcher

Global Editor

No
Nostro
6 August 2011
totally agree with Anna.
@ RF ... pls read the question again. Your answer doesnt make sense
Reply
RF
RF
1 August 2011
Accounting entries are not a valid reason why book value/share price differ.
Reply
An
Anna
1 August 2011
OMG, so much blabber. The correct answer: RoE < cost of equity
If a company does not earn its cost of equity, its PV will be less that its equity.
And this is NOT a killer question, just basic Corporate Finance. Next!
Reply
As
AssetMeerkat
30 July 2011
Is because of anticipated deflation in real asset prices (future book value will be lower). This is akin to contango in the commodity markets (downwards sloping futures curve).
Many oil majors are currently trading below book value. This is why Marathon split itself up to unlock that underlying value. Conoco is doing the same thing; and many shareholders are agitating BP to do the same.
Simples
Reply
Sm
Small_Banker_2011
29 July 2011
When the percieved risk of investing in a firm is higher than the risks reflected in the financial statements and disclosures the stock will trade below book value. Basically for every 1 of fresh capital injection the investors are demanding more RoE to compensate for the higher percieved risk.
It doesn't necessarily mean that these stocks will be buy as a lot of factors need to be taken into the consideration such as the underlying economic conditions, outlook for the industry in which the firm operates, any possible regulatory change and a scrutiny of the firm's financial statements.
There are quite a few examples, RBS is probably trading at lower (or at least very close t0) than it's book value
Reply