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May 22nd
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Checking a stock's book value can be rewarding

moneylogo040411_optBY WARREN BOROSON

Checking a stock’s book value – the value of its tangible assets – can be splendidly rewarding.

In the 1980s, one bank was valuing the shares of Coca-Cola it owned at a ridiculously low price.

Namely, the price the bank had paid when it had bought Coca-Cola at an initial public offering. Back in 1919. Obviously, the bank’s stock was a screaming buy.

Bruce Baughman, who well remembers that incident, focuses on a corporation’s book value when he invests. He runs two funds: Franklin Balance Sheet Investment and Franklin MicroCap Value, the second of which has been closed to new investors for seven years. He works out of Fort Lee. Franklin itself, based in California, is a gigantic mutual fund family, encompassing the celebrated Templeton funds and Mutual Series funds.

In a recent talk in Ridgewood, Baughman explained that in focusing on a corporation’s tangible book value, he ignores such airy stuff as goodwill and such difficult-to-value stuff as patents. He looks at what a corporation would fetch in the open market if it were sold off.

For example, Citigroup is one large bank that Baughman likes. He’s dubious about other big banks, like Bank of America.

Why Citigroup? While it’s despised as much as Bank of America is today, ts tangible book value is lower than its price – and it’s been doing well.

“I have confidence in this company because its tangible book value is growing,” he said. “Even though European debt problems are a major risk.”

Other stocks that Balance Sheet owned recently include Callaway Golf, Chubb Corp., D R Horton, Kelly Services, MetLife, JC Penney, Prudential Financial, Texas Industries, and Watson Pharmaceuticals. baughmanBruce122311_opt_copy

One area he has found to have very good fishing: regulated utilities. He’s done very well investing in Northeast Utilities, Niagara, Mohawk Holdings, Entergy, and IDA Corp.

How does Baughman add alpha, as the saying goes? Earn his salary?

Well, he’s a CPA. And when he studies a corporation’s reported book value, sometimes it seems vastly overstated – for example, goodwill accounting for far too much. And sometimes the book value is vastly understated. A corporation might have hidden assets. Its real-estate holdings might be valued as they were lo these many years ago.

What Baughman does is look for corporations -- sound, well established corporations – trading at a low price-to-book value. And he considers where his analysis, and that of his staff, suggests that the corporation should sell at a significantly higher price to book in the future, and that the book value will grow while Balance Sheet owns it.

When he entered the investment business in the 1980s, he recalled, Wm. Wrigley Co. was a terrific bargain. It was debt-free; it was making money. And it owned valuable land and buildings in downtown Chicago – on the books at their depreciated cost in the 1920s. And such wonderful bargains weren’t unusual in the 1980s.

To illustrate what Baughman tries to do, he uses this example: He tries to buy stock at 0.8 times book value – $8 a share if the book value is $10 a share.

His target price might be 1.5 times book value – and book value might grow at 5 percent a year.

Over five years – the fund’s typical holding period – that’s 25 percent growth ($10 to $12.5). That means a target price of $18.75. The change in the stock’s value: 134 percent ($8 to $18.75). The five-year compounded return: 19 percent.


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