1. The Price-to-Book ratio (PB) is one of the classic investment metrics used by value investors. However, it is no longer a relevant metric for a new class of asset-light tech companies.
2. Book value is about assets deducted away the liabilities or simply what we call net worth of a person. For book value to be relevant, the company must have sufficient good assets under its possession.
3. The problem with the new class of companies is that their asset values are often under-represented in the balance sheet. Take Facebook as an example. Facebook.com is its most valuable asset with a huge number of users get on it every day. But this is not reflected in its balance sheet because accountancy does not know how to value it.
4. Accounting prefers to be conservative and thus ascribed a minuscule value to things that can’t be valued using a recognised method. Looking at Meta’s balance sheet ending in Sep 2021, Facebook.com’s contribution to the assets is zero!
5. Accounting is disrupted as the economy has moved on from a tangible to an intangible economy. It was designed for the industrial age whereby the means of production are physical in nature – machines, equipment, factories, materials etc.
6. These assets have well-established standards of valuation. For e.g., real estate valuation is an industry by itself and the valuation report is recognised by accountants, bankers and government alike.
7. But what about valuation of intangible assets? There are no standards to follow and hence the most convenient way is to ignore their presence in order to be conservative. And we have yet to throw in cryptocurrencies to the problem and how accounting should treat cryptos under liquidity pool staking. People who are responsible for setting industry standards should read ‘Capitalism Without Capital’ and take it seriously.
8. Investors should not wait for the industry standards to catch up. We should adapt and be aware that book value is no longer valid for companies with valuable intangible assets. The investment clues are in the income statement rather than the balance sheet.
9. That said, PB is still useful for companies that are born in the industrial age. Examples are banks, insurance companies, properties and REITs where their assets are valuable and the valuations are adequately ascribed in the balance sheet.
10. The number of investment options have widened in the last decade and investors now need to discern when to use what, based on the type of company being analysed.
