Price to Book value and Next (NXT) shares

[TheMotorcycleBoy]

Hi Everyone,

Have just come back from a week in the Lake District. Alas, it rained a lot, so I managed to plough through the odd book or two. Including this one:

https://www.amazon.co.uk/Warren-Buffett ... B0085W03FM

which I quite liked. In addition to having a very clear example, (very easy to knock up a suitable spreadsheet on return from holiday based on this), of Buffett's method of calculating the Intrinsic value of a stock (sum of discounted cash flows, based of book value growth and future dividends), it also made me prick up my ears to the idea of "Price to Book" value (yes, yet another ratio for me to obsess over!).

Anyway what exactly are we (in 2018) to learn from this ratio?

So in the above book, I've linked the author states, that well regarded investors (e.g. Warren Buffet, Benjamin Graham), shunned the idea of buying shares at much more than 1.5x book value. Indeed quoting from the book:

Benjamin Graham would probably have a difficult time buying this company simply because of the margin of safety discussed earlier. Since the book value is only $20.95 (market = $65), traders could potentially move the market price much lower if earnings began to slow....

So I've had a look around for 4-traders to see what kind of typical Price-to-market values stuff is trading at this year.

https://www.marketscreener.com/SPIRAX-S ... inancials/ is 7.59x
https://www.marketscreener.com/WM-MORRI ... inancials/ is 1.35x
https://www.marketscreener.com/PERSIMMO ... inancials/ is 2.35x

but what surprised me (and almost annoyed me) was that Next (NXT) is at a stonking:

https://www.marketscreener.com/NEXT-9590100/financials/ is 13.5x

As usual would appreciate any thoughts people have both on the relevance of the ratio and it's applicability to various shares,
Matt (and Mel)

So what conclusion should I draw from this? Should I be frightened away from NXT as a result? Or should the guidance be ignored? I'd so far considered Next to be a pretty good bet...

[SalvorHardin]

re. your request in the biscuit bar. First I won't comment about Next. I've never followed it and I avoid retail shares as they aren't within my circle of competence.

Now to "book value" (what we call "Net Asset Value" in the UK). Benjamin Graham's idea that you avoid buying anything above 1.5 x book value is less relevent nowadays because of the increasing importance of intangible assets. Traditional accounting methods are poor at valuing intangible assets, particularly those which are created by their owners. For example, how much do you think that the Coca-Cola brand is worth? It has no value in the accounts. Brands created by companies don't have any accounting value until they are sold.

It isn't just intangible assets that have a problem. For example, a building in American accounting is valued at cost plus improvements minus accumulated depreciation. This figure often bears no relation to market value. Consider The Empire State Building, its accounting value is nothing like its market value because its original value (what it cost to build) has depreciated to nothing over the 87 years since it was built. Its accounting value is the cost of improvements made in the last forty years less depreciation on these improvements (commercial property in America is generally depreciated at 2.5% per year so it becomes "valueless" after 40 years). However under UK accounting rules companies can make estimates of market value and these are entered into the accounts.

In practice Warren Buffett doesn't really follow 1.5 x book value nowadays. Okay, when it comes to Berkshire Hathaway he has historically emphasised multiples of book value but in large part that's because up until the late 1970s/early 1980s Berkshire Hathaway's assets were shares in other companies so it made more sense to value it like an investment trust. Now with the majority of Berkshire Hathaway's assets being deployed in oerating companies which it owns, price to book value is much less relevant. Lots of Berkshire Hathaway's shareholdings have huge price to book value ratios, e.g. Apple's share price is roughly eight times its book value. American Express' is over four.

Oil companies. What's the value of oil in the ground? It's approximately what they spent in finding it minus the proportion of that money which represents oil which has been extracted. So if you spend £100 million to find 1 million barrels then the accounts tell you that you have a more valuable asset than if you spent £2 million to find 1 billion barrels. Seriously. Back on the old Motley Fool in the early 2000s lots of people avoided small oil companies with proven reserves because their shares traded at a premium to their net asset value thanks to this accounting rule (a very popular method was to buy shares whose price was less than their NAV).

Those of us who understood that the NAV was horribly wrong in the case of some oil companies did rather well over the next few years (and for a while the debates about buying shares at prices above their NAV were even more fractious than the current saga in the Biscuit Bar about HYP).

For some companies however book value is however highly important. For example, investment trusts where their NAV is the market value of their investments (mostly shares). NAV is pretty important for Commercial Property companies, however accounting methods are hopeless when it comes to valuing developments (work in progress) where value is basically accumulated costs.

[Walrus]

The only retail exposure I own is Amazon, that should probably tell you enough about my longheld macro views on retail. I don't know enough about high street fashions to feel I have any expertise in investing there.

[cshfool]

NXT doesn't appear to be a book value bargain - that's correct. If one does use a figure of 13.5 for the book value (NXT) then to get a buy at 1.5 x book we could divide the share price of 5668p by a handy (13.5/1.5) =9, so NXT would be a buy at 630p. That seems a bit harsh for a business whose 5 year average EPS is about 416p and would imply a pe ratio of something like 1.6:1, (for 416p eps at 630p) and yielding 27% - doomsday values. Hence the emphasis with Next is, at the moment, on the PE ratio (earnings power), and growth prospects as a valuation method vs bk value.

By the way conventionally sometimes "Intangibles" are disregarded which gives an even lower asset value, its likely that Ben Graham was referring to tangible book values in that 1.5 figure as his aim was to try to erect a margin of safety for the (mostly) defensively inclined readers of his work especially in "The intelligent investor." The aim was really to try to protect the investor against the various sensational price declines which occur now and again. Sometimes crashes come with businesses that are strongly fashionable but with little or no track record in terms of surviving the ravages of multiple business cycles, as he did, living and working through the 1929 panic and subsequent depression when even gilt edged bonds were considered far too speculative for investment purposes. Sometimes its a secular change as happened with the railroads, regardless of size.

Chapter 14 of Grahams "The Intelligent Investor" lists a number of criteria with that 1.5xbk - Adequate size (>$10bn sales at todays level?); Strong financial condition (current assets at least 2 x current liabilities) and not too much debt; Uninterrupted dividend payments for at least 20 years; modest earnings growth over 10 years, moderate PE ratio (not more than 15 times the 3 year average) and 1.5 x P/bk.

Here the aim where possible was to try construct a diversified portfolio that satisfied these at least in aggregate, since few companies could satisfy everything individually (1970). FWIW Stephen Blands [P(ERatio) ,Yield, Assets, Debt], method aka "pyad" value method considered many of these too in a former, more recent Foolish era.

However Ben relates a story of an interest in a small census company that he had studied and worked with, that he brought to his manager when a young analyst, Computing Tabulating and Recording in about 1916. It had very little book value but good earnings prospects but his manager frowned on it as consisting mainly "water" , so the chastened young man did n't mention it again even when it adopted its modern name of IBM, and the company went on to become fabulously successful.

Anyway Book value isn't always key but it does (sometimes) provide a defensive (bouncy) price floor for bigger companies and its certainly become more difficult currently to find decent companies trading at < 1.5 x book, except some of the broadly loathed house-builders of course where expected earnings falls are built in. However no doubt wider book value bargains will come again with the next slump whenever it comes, when some fashionable shares will show declines of perhaps 90% or more as usual, and even average portfolio capital declines of 30%+ are to be expected, yields similarly, after a lag.

As far as Next goes specifically you might like to search for Paul Scotts (aka Paulypilot) knowledgeable writings on this one as he was an FD for a clothing chain before taking up full time investment, and specialises in clothes retail. Let me know what you find,

csh

[TheMotorcycleBoy]

Now to "book value" (what we call "Net Asset Value" in the UK). Benjamin Graham's idea that you avoid buying anything above 1.5 x book value is less relevent nowadays because of the increasing importance of intangible assets. Traditional accounting methods are poor at valuing intangible assets, particularly those which are created by their owners. For example, how much do you think that the Coca-Cola brand is worth? It has no value in the accounts. Brands created by companies don't have any accounting value until they are sold.

A ha! Book value = NAV. Sorry the penny has only just dropped that NAV is net asset value. Since March we've been trying to learn at a rate of knots.

Of course the "real intangible assets" (sorry for the hideous oxymoron), i.e. the ones that the original owning company (in this case NXT) build up are not visible in the balance sheet, (I differentiate these from those which may arise in firms sheets as acquisitions occur, for higher than book prices, which since real money changed hands require accounting), and cannot be priced.

It's rather like setting a price on happiness, I guess. I have no personal sentiment towards the likes of iPhone, Range Rover etc. but to others....

In practice Warren Buffett doesn't really follow 1.5 x book value nowadays.

Yes. I've been reading a bit of his (and commentaries of), and whilst a lot of it makes sense, a lot of his words are almost impossible to apply to modern-day firms. I'm pretty sure that in a lot of investments he breaks his own "rules", re. indebtness.

Okay, when it comes to Berkshire Hathaway he has historically emphasised multiples of book value but in large part that's because up until the late 1970s/early 1980s Berkshire Hathaway's assets were shares in other companies so it made more sense to value it like an investment trust. Now with the majority of Berkshire Hathaway's assets being deployed in oerating companies which it owns, price to book value is much less relevant.

Thanks, that makes sense in what I've read.

Lots of Berkshire Hathaway's shareholdings have huge price to book value ratios, e.g. Apple's share price is roughly eight times its book value. American Express' is over four.

I'd love to know what Warren thinks of Next. I actually think he would quite like it.

Thanks again, for helping me understand, that such ratios, are contextual in their interpretation, the points you made re. the different types of firms were very illuminating.

Matt

[TheMotorcycleBoy]

By the way conventionally sometimes "Intangibles" are disregarded which gives an even lower asset value, its likely that Ben Graham was referring to tangible book values in that 1.5 figure as his aim was to try to erect a margin of safety for the (mostly) defensively inclined readers of his work especially in "The intelligent investor." The aim was really to try to protect the investor against the various sensational price declines which occur now and again. Sometimes crashes come with businesses that are strongly fashionable but with little or no track record in terms of surviving the ravages of multiple business cycles, as he did, living and working through the 1929 panic and subsequent depression when even gilt edged bonds were considered far too speculative for investment purposes. Sometimes its a secular change as happened with the railroads, regardless of size.

So, yes, as I agreed with SH, in my above response the 1.5x guidance is somewhat contextual. I'm still curious, as what factors, in the case of NXT have distorted it in the way that they have.

Chapter 14 of Grahams "The Intelligent Investor" lists a number of criteria with that 1.5xbk - Adequate size (>$10bn sales at todays level?); Strong financial condition (current assets at least 2 x current liabilities) and not too much debt; Uninterrupted dividend payments for at least 20 years; modest earnings growth over 10 years, moderate PE ratio (not more than 15 times the 3 year average) and 1.5 x P/bk.

I think, from my limited research, that this is impossible to find in the UK. The closest I've come across so far would be Persimmon (PSN). But I guess good ol' Warren would not exactly fall in love with the management.

Here the aim where possible was to try construct a diversified portfolio that satisfied these at least in aggregate, since few companies could satisfy everything individually (1970). FWIW Stephen Blands [P(ERatio) ,Yield, Assets, Debt], method aka "pyad" value method considered many of these too in a former, more recent Foolish era.

Yes, I've read all that up. Generally very sensible.

Anyway Book value isn't always key but it does (sometimes) provide a defensive (bouncy) price floor for bigger companies and its certainly become more difficult currently to find decent companies trading at < 1.5 x book, except some of the broadly loathed house-builders of course where expected earnings falls are built in.

Yes. I'm not sure we want to fall too far, before a bounce.

However no doubt wider book value bargains will come again with the next slump whenever it comes

Don't you mean narrower? I.e. for something like NXT, the market price will fall but the book will (obv) remain fixed. Hence the gap tightens?

NXT doesn't appear to be a book value bargain - that's correct. If one does use a figure of 13.5 for the book value (NXT) then to get a buy at 1.5 x book we could divide the share price of 5668p by a handy (13.5/1.5) =9, so NXT would be a buy at 630p. That seems a bit harsh for a business whose 5 year average EPS is about 416p and would imply a pe ratio of something like 1.6:1, (for 416p eps at 630p) and yielding 27% - doomsday values. Hence the emphasis with Next is, at the moment, on the PE ratio (earnings power), and growth prospects as a valuation method vs bk value.

Yes. It looks quite good to me.

But now..

when some fashionable shares will show declines of perhaps 90% or more as usual,

you make me nervous!

As far as Next goes specifically you might like to search for Paul Scotts (aka Paulypilot) knowledgeable writings on this one as he was an FD for a clothing chain before taking up full time investment, and specialises in clothes retail.

Yes. will do. More scribblings to follow.

Matt

[TheMotorcycleBoy]

So more about Next.

My mother-in-law works there... ...has done for 15 years now. They cater for all age groups in mainstream fashion, selling own brand, and other brands (e.g. superdry, ted baker etc.). They have very prestigious sales (I know from Mum-in-law), and I imagine although they are slowly becoming "more online than high street", I also imagine that people en mass (i.e. fashion/brand aware people not me!) will always enjoy spending a few hours around shopping estates having a snack, and browsing (and spending) at a fashion retailer.

I'm still trying to figure out why NXT enjoys this incredible P-to-book value. And re. any fears I may have regards the market price being marked down to the bv, well back in Jan 2009 (tail end of the "credit crunch"), we have the market price=£11.00

book value = equity / number shares
book value = 156.6 / 195.5

therefore

p/b = (11)/(156.6 / 195.5) = 13.73

IOW the high ratio was in effect even in slump times.

As far as Next goes specifically you might like to search for Paul Scotts (aka Paulypilot) knowledgeable writings on this one as he was an FD for a clothing chain before taking up full time investment, and specialises in clothes retail. Let me know what you find,

Yes, I've read some writings by him now. He still sings their praise, it seems:

https://www.stockopedia.com/content/sma ... vp-350343/

and he mentions the idea of them using part of the highstreet operation as the online inventory. Indeed Mother-in-law herself uses the new fangled RF tag reader (makes her about 25x more efficient), which, it seems keep online know where local surplus stock is, to satisfy online request, blah blah,

Matt

[TheMotorcycleBoy]

So this is the challenge. Anyone know of a UK share with a higher price-to-NAV than next (NXT)?

[simoan]

So this is the challenge. Anyone know of a UK share with a higher price-to-NAV than next (NXT)?

Try Glaxosmithkline, Hargreaves Lansdown, Rolls Royce, Domino's Pizza & Thomas Cook to name some well known names from the FTSE350. The are a few others.

To be honest, I think you're barking up the wrong tree with price to book and I never use it although I normally check that Net Tangible Asset Value is positive.

All the best, Si

[WickedLester]

I quite like PTBV as a measure but I don't use it exclusively, i'm happy with a balance sheet I consider "strong", that is a reasonable level of net tangible assets, net current assets and manageable debt which for me usually means (but not exclusively) if i'm buying for the p/e not more than twice expected operating profit.

Also net tangible assets can give a good measure of a margin of safety depending on the quality of the underlying assets. There is a little company I have been following called Autins (yet another one that collapsed in value shortly after coming to market). It trades at a substantial discount to NTA but most of these assets appear to be plant and equipment which would probably have little or no value if the business went bust and the business is struggling at the moment (they're a supplier to the motor industry).

Then there are companies which have substantial discounts to NCA but once again you have to be careful what they are. Take Pittards for example. For some years the company has traded at a steep discount to NTA but every year stocks went up until they were about 1 years worth of sales then promptly a load of them got written off suggesting they hadn't really been making a profit for the preceeding few years. I'd far rather have debtors and cash where there is a fair chance that most of it can be called in at par.

Another ratio you might like to consider Mel is price to sales (PSR). I would consider myself naturally contrarian and like recovery plays. Price to sales can give an indication of potential upside if a struggling company can restore itself to health. I tend to work on the basis that most companies in a competitive environment can look to make a net margin of around 5% so looking at the current market cap of a company and then taking a reasoable mupltiple of what it could be worth if it was trading healthily can throw up some interesting ideas. DX Group is an interesting example of a company trading on a tiny psr but i've never been brave enough to buy any.

[TheMotorcycleBoy]

Then there are companies which have substantial discounts to NCA but once again you have to be careful what they are. Take Pittards for example. For some years the company has traded at a steep discount to NTA but every year stocks went up until they were about 1 years worth of sales then promptly a load of them got written off suggesting they hadn't really been making a profit for the preceeding few years. I'd far rather have debtors and cash where there is a fair chance that most of it can be called in at par.

The situation with Next re. debt and cash is unusual (perhaps?). I have been analysing/following them for a couple of months here are a couple of figures from their 2018 reports:

Gross debt:  1160
Cash:          53
Receivables: 1248
Net Assets:   482
(£ millions)

The interesting thing here is that if you only consider their cash and their gross debt, is it leads one to believe that they are quite indebted. However their "receivables" stockpile is very sizeable, Mel and I speculate that this future cash in the form of their store card/customer finance scheme.

https://www.next.co.uk/nextpay

So they are employing their debt (which we believe they mainly acquired via. fixed rate bond issues) to finance their card scheme (which has an associated 22.9% APR).

This seems quite shrewd to us.

Another ratio you might like to consider Mel is price to sales (PSR). I would consider myself naturally contrarian and like recovery plays. Price to sales can give an indication of potential upside if a struggling company can restore itself to health. I tend to work on the basis that most companies in a competitive environment can look to make a net margin of around 5% so looking at the current market cap of a company and then taking a reasoable mupltiple of what it could be worth if it was trading healthily can throw up some interesting ideas. DX Group is an interesting example of a company trading on a tiny psr but i've never been brave enough to buy any.

The closest we've got to psr

8059 (market cap now) / 4055.5 (revenue for period jan17-jan18) = ~2.0

Matt

[TheMotorcycleBoy]

So this is the challenge. Anyone know of a UK share with a higher price-to-NAV than next (NXT)?

Try Glaxosmithkline, Hargreaves Lansdown, Rolls Royce, Domino's Pizza & Thomas Cook to name some well known names from the FTSE350. The are a few others.

To be honest, I think you're barking up the wrong tree with price to book and I never use it although I normally check that Net Tangible Asset Value is positive.

All the best, Si

I see what you mean:

https://www.marketscreener.com/GLAXOSMI ... inancials/ 57.2x

[TheMotorcycleBoy]

Another ratio you might like to consider Mel is price to sales (PSR). I would consider myself naturally contrarian and like recovery plays. Price to sales can give an indication of potential upside if a struggling company can restore itself to health. I tend to work on the basis that most companies in a competitive environment can look to make a net margin of around 5% so looking at the current market cap of a company and then taking a reasoable mupltiple of what it could be worth if it was trading healthily can throw up some interesting ideas. DX Group is an interesting example of a company trading on a tiny psr but i've never been brave enough to buy any.

What kind of figures do you reckon for P/S? I read that 1 was a nice value to find.

Anyway I've just searched out some examples of price vs sales:

tate TATE = 1.09
next NXT = 1.88
spirax-sarco SPX = 4.7
glaxo smith GSK = 2.63
advanced medical solutions AMS = 8.03

And then Burford capital BUR (which we are invested) is an incredible 14 ish.

However, surely the firms operating margin must be taken into as well though? Since although BUR's P/S is very high, it's operating margin is between 75-80% and has been for the past 4 years or so. So surely in that case the sales are "higher quality" than those of firms running tighter margins.

Thoughts?

[WickedLester]

However, surely the firms operating margin must be taken into as well though? Since although BUR's P/S is very high, it's operating margin is between 75-80% and has been for the past 4 years or so. So surely in that case the sales are "higher quality" than those of firms running tighter margins.

This is a good point. I did mention in my post that I typically expect a mature company with no particular competitive advantage to make margins of around 5% because from experience it's around abouts the norm.

I often shy away from companies with much higher margins, which may seem counter intuitive, because of the risk that the margins are bid away through competition.

One that stands out though for me is Victrex. They have been a great investment but have just one product "PEEK" as far as I know which no longer has patent protection yet apparantly the barriers to entry, that is tooling up to produce it, are so high that they have been able to continue making huge margins for years after their patent protection ran out.

I did buy a few ALY for the psr but just a very few and it has a pretty good balance sheet by the standards of retailers. I also think there remains a fair bit of value in the brand.

Lester