Research suggests that relying on the price/book ratio as a filter for cheap stocks is a mistake. Book value is a measure of a company’s assets, less its liabilities. In theory, if you can buy a company for less than the value of its net assets (a p/b ratio of less than one), you’re potentially snapping up a bargain. If a company is trading for much more than its book value, you might be overpaying. However, a new paper from Travis Fairchild at O’Shaughnessy Asset Management reveals that from 1993 to 2017 firms with negative book value (liabilities greater than assets) and firms that looked expensive on a p/b basis but cheap on other measures tended to beat the wider market. So what’s going on? Two key things, says Fairchild. First, valuable intangible assets — such as a firm’s brand or investment in research & development — are often understated on the balance sheet. Second, long-term assets such as property are often on the balance sheet at below market value due to a firms’s depr...
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