Most people forget that book value is almost always far less than true market value of a company.
Examples:
If Washington Mutual Holdings, or any other company, purchased land and a building in 1988 and paid $20 million,for example, after 20 years of straight-line depreciation, the book value of those assets are zero. However, the TRUE VALUE of that land and building that cost $20million in 1988, would be MUCH, MUCH,MUCH higher than $20 million. Anyone who understands accounting knows what I am talking about. It is not uncommon for a company to go into bankruptcy with a "book value" that is only a fraction of the real assets. The value of assets in a company's financial statements are almost always far lower than the true market value.
There are also factors to consider when assesing a company's true value. You should take into consideration that there are several costs that get expensed every accounting period that are not capitalized as an asset.
"In 2007, the 30 companies constituting the Dow Jones Industrial Average had an average ration of market value to book value of approximately 4.46. The ration for Merck, one of the world's largest pharmaceutical companies, was approximately 6.0. Can you think of an important reason why Merck's market value would be six times higher than its book value?"
"Carter Hawley Hale Stores (CHHS), Inc., was one of the largest department store retailers in the US. In 1991, the company operated over 100 stores in the sunbelt regions of the country. The company's divisions included The Broadway and Emporium. During the 1980's, the company struggled financially and in February of 1991 declared bankruptcy. CHHS's February 2, 1991 wuarterly balance sheet, filed with the SEC and made publicly available, disclosed the following information.
Balance Sheet (condensed)
At February 2, 1991
($ in 000s)
Assets
Current assets $1,154,064
Property and equip,net $511,690
Other assets $89,667
Total Assets $1,755,421
Liabilities
Current liabilities $175,982
Long-term liabilities $1,852,066
Total liabilities $2,028,048
Shareholders' Equity - 272,627
Tot liab and equity $1,755,421
The negative shareholders' equity includes negative retained earnings of nearly $1 billion resulting from operating losses incurred over a number of years.
By the summer of 1991, the company's stock price had dropped to $1 per share from a 1989 high of $8. In June 1991, the following condensed balance sheet information was reported to the bankruptcy court:
($ in 000s)
-----------------------------------------
Property $1,596,312
Debts $1,112,989
Excess of property over debts $483,323
Did the financial position change this dramatically from February to June? No. Differences in reporting requirements by the SEC nd the bankruptcy court cause the apparent discrepancy. First, the property (assets) disclosed to the bankruptcy court does not include accounts receivable and debts do not include the related liabilities for which the receivables had been pledged as collateral. This accounts for the smaller asset and debt figures as compared to those disclosed in the February statement provided to the SEC.
But the striking difference is that the negative equity of $272,627,000 disclosed in the SEC report becomes a positive equity (excess of assets over liabilities) of $483,323,000 in the information disclosed to the bankruptcy court. This positive equity, divided by the number of common shares outstanding, results in a per share value of nearly $16. Why the discrepancy? The answer relates to the valuation of property. In the balance sheet submitted to the SEC, these assets are valued based on their original cost. However, the bankruptcy court requires assets to be reported at fair value (The bankruptcy court requires market value information in order to assess, among other things, the ability of the company to pay its creditors if assets were liquidated). The market value of CHHS's property, which includes some valuable land in locations like San Francisco, was significantly higher than its original cost...."
Washington Mutual Holdings is worth much more than their book value suggested on their balance sheets submitted to the SEC.
In our case with Washington Mutual, we don't have to wonder about whether the Assets and Debts reported to the bankruptcy court are accurate because the answer is, yes they are accurate. The #s disclosed to the court are the real #s and yes, there will be plenty of money to go around. Will the preferreds get paid out in full? Highly unlikely imo. Will the common-stockholders get screwed with their pants on again? Unlikely imo, but it is possible. Do I think we would all be better off if Washington Mutual were in CH 7 liquidation instead? Yes, but it doesn't pay thinking about that because they are not in liquidation, they are restructuring.
In summary, the balance sheet of a company included in filings to the SEC does not directly measure the market value of an entity. The balance sheet submitted to the bankruptcy court is the one to look at. You do not have to worry about these #s going up or down. They are as close to fair market value as you can get. So in our case, you do the math. When examining stocks in the future, make sure that you do not base your decisions on the balance sheet alone (especially if it is a balance sheet submitted to the SEC) A company's balance sheet should be used in conjunction with other financial statements, such as the statement of cash flows,to judge the market value of an entity.
I am not here to give anyone an accounting lesson, nor will I be answering questions regarding Generally Accepted Accounting Principles, nor do I think I know it all, because I certainly do not. I just wanted to share some accounting knowledge that you all might benefit from in the future.
Best of luck to everybody, relax, and enjoy your weekend!
