What are companies worth? Investors decide that every day by pushing share prices higher or lower, resulting in a change to each company's stock market value. Accountants have a different answer. Each quarter, they estimate what a company would receive if it suddenly ceased operations, auctioned off its hard assets and used the proceeds to retire its debt. That's called tangible book value.The two measures are sometimes close, but they can also differ dramatically. Consolidated Edison (ED: 44.89, +0.12, +0.26%), New York City's power company, is valued by stock investors at just 20% more than its tangible book value. Google's (GOOG: 500.03, -0.05, 0.00%), on the other hand, trades at nearly five times its tangible book value, because most of its perceived worth lies in things like intellectual capital and profit power, not in the value of hard assets.
That comparison might make tangible book value seem best left to old-economy investors, but in studies it compares favorably with earnings in terms of its ability to predict stock returns for many types of companies. That's perhaps because the profit margins on which earnings rely tend to mean-revert; that is, unusually profitable companies tend to eventually fall victim to competitors, and struggling companies are often forced by investors to make improvements.
The companies that seem like powerful earners today, whose stock prices are accordingly high relative to earnings, might underperform shares of the three unassuming companies listed below. Their stock prices are low relative to their tangible book values, compared with industry averages. They also seem financially strong; each boosted its dividend payment within the past year.
Archer Daniels Midland
Price/tangible-book ratio: 1.2
Dividend yield: 2.3%
Dividend yield: 2.3%
Archer Daniels Midland (ADM: 27.19, -0.32, -1.16%) has long turned crops like corn, wheat and oilseeds into processed foods and fuel. In recent years, the company has diversified further into crops like palm and sugar; developed new fuels and industrial products; bought its way into lucrative source markets like Brazil; and expanded its operations into activities like transportation, to better control the profitability of crops on their way to becoming end products. Those efforts counter one common investor reservation about the stock: that Archer Daniels' profits tend to ebb and flow with the price of commodities. "Notwithstanding the uncertainty around which division will generate how much profit, the reality is ADM generates among the most consistent earnings base among our coverage universe," wrote Kenneth Zaslow, an analyst with investment bank BMO Capital Markets, in a note to clients last month. In addition to a low price/tangible-book ratio, Archer Daniels currently has a price/earnings ratio in the single digits.
Lowe's Companies
Price/tangible-book ratio: 1.8
Dividend yield: 1.8%
Dividend yield: 1.8%
Home-improvement retailer Lowe's Companies (LOW: 22.62, -0.06, -0.26%) faced a grim business climate over the past three years. House sales plunged, consumer spending dried up and a spike in unemployment hit builders especially hard. Predictably, sales at longstanding Lowe's stores slid throughout those three years, but the company managed to produce a cumulative $3.5 billion in free cash, and to pay shareholders $1.3 billion in dividends. Not bad for a slump. Morningstar Equity Research estimates that as the housing market stabilizes, Lowe's will generate $10 billion in free cash over the next five years. That's enough for the company to repurchase about 30% of its stock while keeping the dividends coming.
Target
Price/tangible-book ratio: 2.6
Dividend yield: 1.8%
Dividend yield: 1.8%
More bad news for the local grocer: Target (TGT: 53.67, -0.45, -0.83%) is going the way of Wal-Mart (WMT: 51.55, +0.14, +0.27%) by stuffing supermarkets into more than 300 of its stores. That follows a test of the program in Philadelphia that analysts say must have been plenty successful to convince the company to quickly renovate nearly one-fifth of its chain. Supermarkets aren't terribly profitable; the average chain turned just three cents of each sales dollar into operating profit over the past year, versus seven cents for Target. Then again, Target's approach involves using space it already pays for, so incremental sales could be plenty profitable. Analysts over the past three months have raised their earnings forecasts for Target's fiscal year ending January 2012 from $4.24 a share to $4.43 a share. That puts the shares at about 12 times next year's estimated earnings.
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