Avoiding Common Stumbling Blocks 233On paper, book value looks painfully simple:Assets $ 800 million
Liabilities $ 500 million
Equity (Book value) $ 300 millionClearly, book value is a very important fi gure for value inves-
tors since paying less than a company is intrinsically worth is the
cornerstone of the value investing approach. Indeed, investing in
businesses at a discount to book value is one strategy many value
investors employ, and they can be quite successful. However, to
properly appreciate and exploit businesses trading at less than
book, a clearer understanding of book value is in order.
An often - forgotten fundamental rule in business is that any asset
is worth what the next person is willing to pay for it. Market prices
aren ’ t established out of thin air but rather are based on the supply -
and - demand mechanics of that particular asset. When equities are
rising, it ’ s because there are more buyers than sellers, thus increas-
ing demand, which means sellers have better prices to choose from.
The opposite is also true. When more sellers exist than buyers,
there is more supply than the market demands. Thus, sellers have
very few options and usually are forced to accept lower prices. This
pricing dynamic works across every major asset class — real estate,
cars, and commodities — not just stocks.
Value investors who have a keen understanding of this market
mechanism recognize one potential limitation of overreliance on
book value. Simply buying a share of stock in a business for $ 10
when its book value is $ 25 per share is no guarantee that a capital
gain will be realized. That ’ s not to say that buying a business for less
than 50 percent of its book value is not an attractive proposition
but rather to say that there is no immediate catalyst in the market
that will get the share price to advance simply as result of a price -
to - book - value discount. If there are far more sellers of equities
than buyers, then stated book value might not mean much because
investors currently do not believe that the asset value will hold.CH011.indd 233CH011.indd 233 9/2/09 11:51:53 AM9/2/09 11:51:53 AM