My friend in telegram asked me the title question. For him, I derived two answers, hard and easy answers.
Hard Answer
When it comes to valuating a business, there are 2 areas of
consideration:
1.
What does the business own?
2.
How much the business does is earning?
However, in this blog sharing, I wouldn’t be sharing on pointer
2. Thus… let’s start with pointer 1.
What does the business own
Assuming there are 3 companies:
1.
Company (A) has Singapore Treasury Bonds (rating:
AAA), Investment properties that generate Rental income, and some companies’
shares
2.
Company (B) has quite a lot of stationary
inventory and some machinery like photocopy machines and binding machines.
3.
Company (C) has groceries inventory both fresh
and non-fresh, for example, fresh fish, meat, vegetable, and canned and frozen
food. It also has some machinery to help its employees with their operations,
for example, trolleys, meat-slicing machines, etc.
Just looking at these companies and their assets alone,
which do you prefer to invest in?
For me, I will prefer to invest in (A). As these assets can
sell almost at their face value or even if I don’t sell them, the assets will
automatically generate passive income for me.
It isn’t fair to say that (B) and (C) aren’t good
businesses. But there are more factors for me to consider determining that. For
example, location, how often their inventory turnover is, and how fast, in
particular for (C) thanks to their fresh groceries inventory.
If you look in another way, some of the (C)’s assets do not
have the luxury of time, and (B) and (C) required me to operate the business to
ensure sales and income. While (A) most likely does not require me to be this
active.
Thus, if a company has similar assets in its balance sheet
like (A). The Price to book value (PB) ratio may be a good idea to use as a gauge.
Usually, when I research the company, I will look at what
business it is doing, what assets do its own, how much percentage of its assets
is high quality (for example, AAA bonds, investment properties, cash), and how
much is book value per share.
So let’s assume that (A)’s book value per share is $100. The
asset allocation is 45% AAA bonds, 45% investment properties, and 10% other
companies' shares. If the price for (A) share is $50, making the PB ratio 0.5,
this might be a good investment opportunity. This gives investors a chance to
buy the company for less than what the company paid for those assets.
Of course, there are other factors to consider, but this is
a simple example to valuate a business using PB.
In short, the hard answer to my friend’s question is:
Depends on the assets the company owns. The more valuable
the asset the company owns, PB seems to make sense.
Easy Answer
So what is the easy answer? In very simple terms, Banks,
Insurance companies, and REITs are great usual suspects. As they usually have
assets that generate income for the companies.
Banks have loans that generate interest income. Insurance
companies usually buy high-quality bonds to earn interest. REITs have
properties to earn rental income.
And usually, their allocation for these types of assets is a
pretty high percentage in their balance sheet.
