Read the Fine Print
Book value can point to bargains -- or to stocks that deserve their low prices


VALUE INVESTORS HUNTING FOR inexpensive stocks these days face a daunting challenge: As a result of the broad rise in the market indexes the past 11 months, stocks that are cheap based on earnings, cash flow, and book value are rare as Siberian tigers. And bagging them requires a cautious approach.

Two weeks ago, Barron's ran an article about the small number of companies in the Standard & Poor's 500, mid-cap and small-cap indexes that traded for under 10 times earnings. This week, we're seeking attractive stocks based on another yardstick: book value per share.

Book value, a measure of shareholder equity, is derived by subtracting debt and other liabilities from assets. To arrive at book value per share, divide shareholder equity by the number of shares outstanding.

Famed investors like the late Benjamin Graham used book value as a gauge of liquidation value. Buying a stock below book can provide what Graham called a "margin of safety." But stocks with price-book ratios that are decently low are scarce now -- and many of those that do qualify have problems. Within the S&P 500, only 11 stocks trade below their book value. Inside the S&P 400 mid-cap index, there are just eight (see table).

"In the past, low price-book investing turned up appealing stocks that were being neglected or ignored by the market. Now, many of the companies have significant issues, like debt problems or weak earnings," says Michael Green, portfolio manager at Moody Aldrich Partners, a Boston investment-management company. He advises investors to tread carefully.

The perils of playing in this area were illustrated Thursday, when UnumProvident, the country's leading disability insurer, slid by $1, to 14.75, after reporting a fourth-quarter loss stemming largely from a $440 million charge to boost reserves for its disability business. One of the stock's main allures, its book value, shrunk by $4 a share last year to 24. UnumProvident looks inexpensive trading for less than 10 times projected 2004 profit of $1.70 a share -- unless, of course, there are more adverse developments.

"A price-book ratio below one is no guarantee of safety," Green adds. It's important to examine the quality of a company's assets. Many value investors focus on tangible book value, which excludes goodwill and other intangibles. LaBranche, a leading New York Stock Exchange specialist and Blockbuster, the video chain, are companies whose book values consist largely of goodwill -- an intangible asset. LaBranche recently wrote down part of its goodwill, and more writedowns are possible, given its eroding profits and the threats to the specialist business.

Green notes that just 6% of New York Stock Exchange companies now trade under book value, versus 25% in March 2000, when the major averages peaked (Green excludes closed-end and bond funds in making this calculation.) Cheap stocks actually were more plentiful during the market bubble than they are now, due to the narrow breadth of the technology-led market advance in 1999 and early 2000. Over the past 75 years, low price-book stocks on the Big Board were most abundant at the historic market bottoms of 1932 and 1975.

Still, there could be a few gems now, including Loews, Toys "R" Us, Amerada Hess, CNA Financial, Haggar and Syms.

Loews has risen 40%, to 54, since its November low, but it still trades below its book value of $57 a share. And that book value understates Loews asset value, dominated by its stakes in three public companies, CNA Financial, Diamond Offshore Drilling and Carolina Group, a tracking stock for Loews' Lorillard cigarette business. Loews' asset value is probably around $75 a share. Fans argue that the stock offers a "double discount," because CNA, Diamond and Carolina Group trade at a discount to their peers and to their own assets.

One fan of CNA is Tom Kahn, co-director of investments at Kahn Brothers, a New York investment firm that hews to Graham's principles. Tom Kahn's father, Irving, 98, worked with Graham, starting in the 1930s. "Unlike most investors, who start with the income statement, we start with the balance sheet," Kahn says. His firm owns a bevy of stocks that trade at -- or once traded at -- a discount to book value.

CNA, 91% of which is owned by Loews, has had the worst financial performance among the major property and casualty insurers, and its stock price reflects that sorry record. CNA, at about 26, trades for 78% of book value, while leading rivals like Travelers and Chubb fetch more than 1.5 times book value. CNA took a $1.8 billion charge in the third quarter to boost reserves, its second monster charge in two years. Kahn is betting that the company finally is cleaned up and that the business it has booked in recent years is quite profitable. If Kahn's right, CNA could trade into the mid-30s over the next year. CNA is expected to earn around $2.50 a share this year.

Kahn also is partial to Syms, the Secaucus, N.J.-based, off-price retailer known for its slogan: "An educated consumer is our best customer."

Syms, an also-ran in the hot, off-price-retailing sector, is probably worth more dead than alive because its results have been weak in recent years. The shares, at 7, trade for half their book value, which probably is understated because of the company's Manhattan real-estate holdings.

Syms management, led by founder Sy Syms and his daughter, CEO Marcy Syms, tried to take the company private in 1995 at $8.75 a share, but backed off following shareholders' complaints that the deal undervalued the company. The family owns more than half of the 16 million outstanding shares. Kahn believes the Syms may tire of losing money and sell or liquidate the company.

Haggar, a maker of men's pants, also appeals to Kahn, who notes that its shares, at 19.70, trade at a discount to its $24 book value.

Haggar may have a dated image, but the company has done well in a difficult period for the apparel industry. Kahn says that while Haggar "may not be an innovator like Intel," its R&D efforts have yielded such products as more comfortable pants for overweight men. Kahn cites Haggar's "Comfort Fit" pants that feature a hidden, elastic waistband. Kahn swears by them.

Moody Aldrich's Green likes Amerada Hess, the New York-based energy-exploration company and refiner that's one of the few sizable oil and gas companies trading below book value. Hess, at 57, has a book value of $60 a share.

Hess has a sizable debt burden, but has cut that load to $4 billion through asset sales. The company is valued at about four times cash flow, less than half the valuation of major oil companies. Hess owns a New Jersey refinery and a half-interest in a giant facility in the U.S. Virgin Islands. Many Street analysts rate it a Sell -- but it's not expensive, trading at 14 times projected 2004 profits.

Toys 'R' Us has rallied in the past six weeks, rising to 14 from 11, despite a weak fourth quarter, amid hope that it may be close to a restructuring that will unlock the value of its Babies 'R' Us division and sizable real-estate holdings. Toys 'R' Us may no longer be on the bargain counter, but it could rise into the high teens in the next year if it restructures or if its core U.S. toy-retailing operations improve. The bad news: Powerful Wal-Mart uses toys as a loss leader at Christmas. The good news: Rivals like KB Toys and FAO Schwarz have filed for bankruptcy.

Pathmark Stores, the Carteret, N.J.-based supermarket operator, appeals to Green because it trades at a nice discount to its book value and could be a takeover candidate in a consolidating industry. The shares, which trade just below 8, amount to "leveraged" equity because Pathmark's market value of $240 million is a fraction of its debt of $650 million. Pathmark, which emerged from bankruptcy in 2000, expects to earn about 55 cents a share in its just-concluded fiscal year and a similar amount in 2004. With 143 stores, it's one of the leading supermarket chains in the fragmented New York, New Jersey and Pennsylvania markets.

One of the most debt-laden companies on the list is Six Flags, operator of 39 amusement parks, including Six Flags Great Adventure in New Jersey and Magic Mountain near Los Angeles. Six Flags' long-term debt totals $2.3 billion -- more than seven times its projected pre-tax 2003 cash flow of $300 million. Six Flags uses most of its cash flow to pay interest and capital expenditures, leaving little for debt reduction. At 7, it trades at a discount to its $13.25 book value, but it's debatable whether it could fetch anything close to $13 if sold.

Winn-Dixie Stores, the Jacksonville, Fla.-based supermarket operator, has probably been hurt more than any other major chain by Wal-Mart. The stock has fallen 3 points, to 6, since the surprising news of a sizable loss in the December quarter. Most analysts now expect Winn-Dixie to operate in the red this year.

In a recent client note, JP Morgan analyst Stephen Chick said the $6 a share in tangible book value "could support the stock" but that he's concerned about further operating losses and Winn-Dixie's debt and lease obligations.

This points up the hazards of investing in many of the stocks on the list. Ben Graham wouldn't touch most of them.

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