November 24, 2008

Buy a Company with a Future (Book Value) (Session 3)


Book Value is a pretty easy one as compared to Price to Earnings. So let’s get into it we will need it for other calculations.


What is it?

(Total Assets – Intangible Assets (Goodwill) – Total Liabilities)

What does it tell us?

As with price to earnings ratio imagine if you will that you are buying a company but instead of running the company you are closing it out and selling off all the equipment. To do that you have to pay off the debts of course no one is going to let you walk out the door without paying the bills.
So if you have $1,300M in current assets, Current and long term Liabilities of $600M and preferred shares of $450M. Then you have a book value of:

(Total Assets – Intangible Assets (Goodwill) – Total Liabilities)
($1300M - $600M - $450M) = 250M.

So basically if you close up shop after you buy the company pay off the bills and you pocket 250M- not too shabby.

What does Graham use?

A book value of greater than 0. The company has to have enough to clean off the liabilities that are coming soon and will come in the future- basically it has to be able to afford its own future.