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Strategies & Market Trends : Value Investing -- Ignore unavailable to you. Want to Upgrade?

To: Alejandro who wrote (3712)	4/1/1998 12:11:00 PM
From: Kent J. Davis	Read Replies (2) \| Respond to of 78520

ALI, I can appreciate where you are coming from, almost every text out there will go to great lengths to downplay bookvalue claiming it is obsolete or misstated. Yet in the next chapter they key in on return on equity , which uses book value in the denominator. I think the big problem is that most folks don't understand what happens above and below book value. To me the price of the stock relative to book determines the proper financial strategy for the firm. You are correct, I use book to measure ( like a yard stick) or benchmark value. My original work on the subject started in the early 1980's when I owned lots of shares (for me at least) of Mattel ( the toy Maker). They were in big trouble when their intellivision product became obsolete. I proceeded to write a letter to the board of directors suggesting that they buy back some shares- in the letter I made a bold statement which went like this, " Earnings vary as a function of stock price rather stock price varring as a function of earnings". I got a very interesting reaction- they called me up and said the board had talked about this particular statement for several hours. The financial VP suggested that this was something that I should research further. Shortly, thereafter Mattel took a $800 million write- down and struck an equity deal with a firm I have since forgotten. As a result They survived. That event started my work/research into book value and it's relationship to corporate financial strategy. If you know the Price to Book ratio, you can pretty much figure out ( at least conceptually) what is happening in the board room. As far as I am concerned , this is the most important financial ratio that exists. Kent

To: Alejandro who wrote (3712)	4/1/1998 7:25:00 PM
From: Chuzzlewit	Respond to of 78520

Ali, I've been wrestling with the problem for some time. I think there is a good analogy to be made here to the leasing business. Suppose you lease an asset to another individual, and you want to sell that lease to a third party. What is the lease worth? Answer: Case 1: if bankruptcy is not an issue it is the capitalized stream of payments called for under the lease. Case 2: if bankruptcy is a potential issue, it is the sum of the capitalized lease payments likely to be received plus the liquidation value of the asset. Now here's the point. In neither case is the historic or carrying value of the asset an issue. It is irrelevant. I believe that it's exactly the same in a company. What I care about most are the capitalized value of future free cash flows. But if the value of those cash flows is exceeded by the value of the assets that generated them I suspect that such a business is ripe for liquidation. Regards, Paul