This blog is part of a new series on Institutional Investor entitled Global Market Thought Leaders, a platform that provides analysis, commentary, and insight into the global markets and economy from the researchers and risk takers at premier finanical institutions. Our first contributor in this new section of Institutionalinvestor.com is AllianceBernstein, who will be providing analysis and insight into equities.
Okay, the title above is a trick question. Price-to-book (P/B) value is always price-to-book value—but it can mean different things in different industries and, especially, in different countries. Ignoring these differences can lead to poor investment decisions. But investors can be savvier in their analysis of the numbers by systematically taking advantage of insights about local accounting principles.
Price-to-book value, for example, is a standard measure of valuation that shows the relationship between a stock’s price and the net asset value (assets minus liabilities) of the underlying company. The problem is that accounting standards aren’t the same around the world. For example, in the US, research and development (R&D) costs are sliced off a company’s book value. In Germany, research costs are sliced off—but development costs can be, and usually are, added back to book value. This discrepancy can skew comparisons between some US and German stocks, for instance, by quite a bit. An assessment of Daimler’s and General Motors’ valuations as of April 2011 provides a good example.
By using numbers directly from company reports, the P/B for Daimler and GM, respectively, was 1.50× and 1.87×. Given those numbers, all else being equal (which is rarely the case, but we’re simplifying here), you’d pick Daimler for your portfolio over GM; it would look 20% cheaper.
But guess what would have happened if you amortized research costs over the five years ending in 2010, added them back to Daimler’s book and also added back both parts of R&D to GM’s book, to create a fair comparison? Their P/Bs would move much closer together; in fact, they would end up only 3% apart. On a “true” P/B basis, neither company was a more compelling value than the other.
The playing field could also have been leveled by adopting International Financial Reporting Standards (used by all European Union countries) in computing GM’s P/B, or adopting US generally accepted accounting principles for Daimler; the results would be similar. Any route would require breaking with at least one country’s conventions in the interest of making a fair comparison.
While some investment managers do make such adjustments on an ad hoc basis, the big breakthrough would be to do so routinely—and not just for P/B but for a variety of factors that might go into a purchase decision, drawing from both quantitative and fundamental insights. In the future, if accounting conventions were harmonized globally, many of these adjustments would become unnecessary. But we’re not there yet.
And so the example of Daimler and GM shows why in the current system comparing apples to apples is key. Or, to put it another way, it’s why you should watch your P’s and your B’s.
Andrew Chin is Global Head of Quantitative Research and Investment Risk at AllianceBernstein
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all Alliance Bernstein portfolio management teams.
