Book 'Em!
Thursday, June 4, 1998
by Jeff Fischer
(JeffF@fool.com)

ALEXANDRIA, VA (June 4, 1998) -- Even following today's 1.6% rebound, the Nasdaq market is more than 8% below its April high, meaning that it was down more than 10% as of yesterday.

Does that count as a market correction? Rather than counting for anything, it's more likely that we'll continue to hear from the Wise that today's investors have "never seen a declining stock market," despite the summer of 1996, the fall of 1997, May of 1998, and so forth. During each of these periods certain stock market indices declined significantly, often nearly 10%.

Having drifted since April, stocks are languishing at best -- up one day, down the next; up another day, down the next. If you've known many artists in your life, this market might remind you of them: downright moody. Heck, if you find yourself longing to walk the Left Bank of Paris and, in your imagination, you duck into a dark cafe to dream up your next lethargic painting -- back off. You're too near the beast. Leave the stock market alone for a while and enjoy the early summer.

In the Fool Port we're keeping our sunny disposition thanks to resilience in America Online, Amazon, and Lucent. Other than that, we have a smattering of holdings that would be better off left under wraps, never seeing the light of day. But like Van Gogh's work, perhaps these holdings will rise in value and become highly saleable some day. On Tuesday we looked at the most damaged pieces in our collection: Iomega, 3Com, KLA-Tencor, and Innovex. Following Tuesday, our thought is:

Book 'em!

Some of these stocks have declined sharply enough that it's suddenly interesting to compare them to their respective book values. Book value as a valuation method hasn't been mentioned much in recent history, and some people have even gone so far as to hypothesize that book value is no longer relevant to investing except when dealing with financial stocks. Brand and market position (intangibles) supposedly add so much value that if a company like Coca-Cola (NYSE: KO) trades at 25 times a traditional book value measure (as it does), investors shouldn't blink an eye.

For comparison, the average Dow Jones Industrial stock trades at 5.8 times book value. But what exactly is book value?

Book value is literally the value of a company as stated on its accounting ledger. It's figured by looking at little more than shareholders' equity, which can be found on the balance sheet. Keep reading -- it's easy. Shareholders' equity is simply total assets minus total liabilities. But, book value itself can differ from shareholders equity if intangibles are not subtracted. So, a more complete definition of book value is "total assets minus intangible assets (goodwill or patents) minus total liabilities." Whatever is left represents the company's book value.

So, displayed simply:

  1. Shareholders equity = Total Assets - Total Liabilities (often the same as book value)

  2. Book Value = Total Assets - Intangible Assets - Total Liabilities
As mentioned above, the average Dow Jones Industrial stock is trading at 5.8 times book value. In the past five years, the highest price-to-book value for the Dow has been 5.9 (in early April) and the lowest was 3.2 in 1994. As merely a point of comparison, bank and financial stocks are currently being acquired at around 1.8 to 2.0 times book value -- but book value is much more meaningful in valuing these stocks. Higher book values for branded consumer companies are the norm.

Beyond that, small and mid-cap companies with promising futures are usually granted higher prices compared to book value than is a mature Dow Jones giant. As large mid-caps, Oracle Corp (Nasdaq: ORCL) and Cisco Systems (Nasdaq: CSCO) trade at 10 and 15 times book value, respectively. Technology stocks often trade at higher premiums to book value because much of their value is represented by intellectual property, technology lock-downs, and market share inertia.

But what about our little darlings? As detailed on Tuesday, all of our four languishing companies have strong cash balances and minimal debt, as well as businesses that have built shareholders' equity. With their stock prices hitting new lows, many of these puppies are reaching valuation levels not seen since at least 1993 or 1994. That doesn't automatically mean that they're cheap -- they're falling for a reason. These companies haven't grown earnings recently and aren't presently expected to grow them much in the near future.

Over the next five years, though, each company is projected to grow earnings at a market-beating pace. So if our companies can execute (a large "if"), patient investors might find good value at these lower prices. Might. Asia could damage the semiconductor equipment and disk drive industry for years, and Iomega might languish again as it has in years past. As for 3Com -- one word, Cisco.

Nothing is that cut and dry though (we're swinging back and forth here like the market itself), and many of the woes experienced by these companies aren't company-specific and are arguably temporary, so let's review the numbers.

Iomega (NYSE: IOM) has the lowest book value per share of the four stocks. Its book value is the same as its shareholders equity (so you merely find the shareholders equity on the balance sheet and divide it by the total diluted shares outstanding). Iomega's book value is $1.67 per share. Trading at $5 3/4, the company is valued at 3.3 times book value.

With nearly $1 billion in cash, 3Com (Nasdaq: COMS) has a book value of $7.35 per share. At $26 1/2, the stock is trading at 3.6 times book value. 3Com has risen the past two days on news that it was approved as a potential provider in a $1 billion network upgrade being performed by the U.S. Navy.

KLA-Tencor (Nasdaq: KLAC) has the highest book value of the four stocks at $13.50 per share. Good old KLAC is trading at slightly over 2 times book value, and though this type of cyclical company is usually granted lower valuations like this, peer company Applied Materials (Nasdaq: AMAT) is trading at 3.3 times book. This doesn't mean that KLAC can't drift to 1.5 times book value, or even 1 times book value. It would be quite a deal at that price, though. We should see an earnings report from KLA-Tencor soon.

Holding $3.19 per share in cash, Innovex (Nasdaq: INVX) has a book value of $6.41 per share. With its stock priced at $17, Innovex is trading at 2.6 times book value. That's a little unusual for a company with double-digit profit margins, but we must consider the industry (unfortunately). Still, this might be considered a low valuation for a company with this past growth rate. Is the future really drying up that quickly? Innovex's book value has risen every year for the past ten, beginning at $1.15 per share in 1988.

So 2.0, 2.6, 3.3. and 3.6 -- those are the price-to-book ratios given to these four stocks. All of our companies are trading at substantially lower valuations, in this regard, than the average Dow Jones Industrial stock, which trades at 5.8 times book value. What does this mean? Nothing, comparatively. Comparing random stock valuations to one another is like comparing France to Germany -- doesn't mean much; things are what they are. But independently, at least we can hope that our four stocks are near the low-end of their possible valuations. (Hey, we're hoping!)

As always, the question one should ask is, "Can I find a better place for my money?" When you ask that question, remember that valuation usually does matter. If the market turns sour, book value suddenly takes on more importance, and we might hear it mentioned even more often than we hear of P/Es or price-to-sales ratios. If there isn't earnings growth for a few years, book value can matter. It's always during really great times that these "old valuation" methods are given the heave-ho and sworn off forever -- forever being ended during the next negative phase of the market, even if it's forty years down the road.

Finally, if you couldn't listen to the 3Dfx (Nasdaq: TDFX) audio interview, the transcript is now available.

And to close, if you're an educator or administrator in the education system, please take our Foolish survey today! It's quick and you might win something. More importantly, though, you might help the Fool with its long-term goal of improving the financial education given in schools, something you might agree could be improved upon.

Be Foolish!

--Jeff Fischer

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TODAY'S NUMBERS

Stock Change Bid ---------------- AMZN +1 3/8 43.63 AOL +2 9/16 81.25 T +1 1/4 60.88 DD + 5/16 76.75 DJT --- 8.56 XON +1 5/16 70.31 INVX - 3/8 16.88 IP + 5/8 47.63 IOM - 3/16 5.75 KLAC - 1/2 28.06 LU +2 3/8 71.88 COMS +1 1/2 26.50 TDFX - 1/16 18.19 SPY +2 109.88
Day Month Year History FOOL +1.88% -2.08% 12.81% 278.59% S&P: +1.12% 0.37% 12.82% 138.84% NASDAQ: +1.59% -0.50% 12.71% 145.76% Rec'd # Security In At Now Change 8/5/94 710 AmOnline 3.64 81.25 2134.33% 5/17/95 1960 Iomega Cor 1.28 5.75 349.08% 10/1/96 84 LucentTech 23.81 71.88 201.89% 9/9/97 580 Amazon.com 19.11 43.63 128.27% 8/12/96 130 AT&T 39.58 60.88 53.81% 2/20/98 215 DuPont 59.83 76.75 28.27% 1/8/98 115 S&P Depos. 95.91 109.88 14.56% 2/20/98 200 Exxon 64.09 70.31 9.71% 2/20/98 270 Int'l Pape 47.69 47.63 -0.14% 4/30/97 -1170*Trump* 8.47 8.56 -1.11% 1/8/98 425 3Dfx 25.67 18.19 -29.14% 8/24/95 130 KLA-Tencor 44.71 28.06 -37.24% 6/26/97 325 Innovex 27.71 16.88 -39.10% 8/13/96 250 3Com Corp. 46.86 26.50 -43.45% Rec'd # Security In At Value Change 8/5/94 710 AmOnline 2581.87 57687.50 $55105.63 9/9/97 580 Amazon.com 11084.24 25302.50 $14218.26 5/17/95 1960 Iomega Cor 2509.60 11270.00 $8760.40 10/1/96 84 LucentTech 1999.88 6037.50 $4037.62 2/20/98 215 DuPont 12864.25 16501.25 $3637.00 8/12/96 130 AT&T 5145.11 7913.75 $2768.64 1/8/98 115 S&P Depos. 11029.25 12635.63 $1606.38 2/20/98 200 Exxon 12818.00 14062.50 $1244.50 2/20/98 270 Int'l Pape 12876.75 12858.75 -$18.00 4/30/97 -1170*Trump* -9908.50 -10018.13 -$109.63 8/24/95 130 KLA-Tencor 5812.49 3648.13 -$2164.37 1/8/98 425 3Dfx 10908.63 7729.69 -$3178.94 6/26/97 325 Innovex 9005.62 5484.38 -$3521.25 8/13/96 250 3Com Corp. 11715.99 6625.00 -$5090.99 CASH $11558.06 TOTAL $189296.50

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