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March 30, 2012

Tangible Book Value Analysis Hurts Starwood, Helps Newmont Mining

by Sridharan Raman.

An ever-popular way for analysts and investors to determine whether a stock is cheap or pricey is the venerable price-to-book ratio. Generally speaking, the lower the P/B ratio, the “cheaper” the company. But that doesn’t tell the whole story. Investors searching for so-called “cheap” companies can get better results than by screening by price-to-book value alone if they can find a way to “back out” intangible items, such as goodwill, from a company’s book value. That’s because book value by itself may cause analysts to reach incorrect conclusions about valuation. That is the conundrum the StarMine research team set out to address when we applied StarMine’s new measure of Price to Tangible Book Value per share to two stocks. The results of that analysis, presented here, show in just how such calculations can help. After adjusting for intangibles, hotel and resort operator Starwood Hotels may be a less attractive investment than it first appears, while gold producer Newmont Mining (NEM.N) takes on some fresh luster as a stock that may offer value for patient investors.

As a reminder, book value refers to the accounting value of net assets (also referred to as shareholders’ equity) on a company’s balance sheet at the end of the period for which the company is reporting its results. Tangible book value per share (TBVPS) is a calculation excluding balance sheet items such as goodwill (including the amount paid over and above the book value of a company purchased) and the value of intangible assets (such as patents). The results provide investors and analysts with a more conservative view of a company’s potential liquidation value. Tangible assets can be sold, unlike goodwill, where management can damage a company’s valuation without warning by writing down the value of goodwill on its books.

When researching the usage of book value as a valuation tool, our quantitative research team found that its effectiveness depends on the ratio of intangibles to total assets. The StarMine Relative Valuation (RV) model combines six ratios, including price to book, to create a more complete evaluation of how cheap or expensive a company is relative to others. Reflecting research findings, the model increases the weight it places on the price to book ratio for companies with fewer intangibles on their balance sheets, and vice versa.

The two examples below show how modifying the traditional concept of price to book value — adjusting the ratio to include only tangibles — can transform the perception of individual stocks in the eyes of investors.

STARWOOD HOTELS & RESORTS WORLDWIDE, INC. (HOT.N)
Starwood’s trailing 12-month P/B ratio currently hovers at around 3.9x, as shown in the chart below. The forward P/B is 32% above its 10-year median but still 33% below the highest P/B level recorded during the last ten years. However, once you remove intangibles from the picture, the current P/TBVPS ratio reveals it is actually trading at a rather pricey 12.8x. That’s because on the hotel chain’s balance sheet, the $9.6 billion of book value includes $2 billion of goodwill and intangibles: let the analyst beware.

Chart 1: STARWOOD HOTELS & RESORTS PRICE/BOOK

StarMine’s Analyst Revisions Model gives Starwood an attractive score of 76 out of a possible 100. (The higher the score, the greater the likelihood of future outperformance.) But other models rank Starwood in the bottom 30% of publicly traded US companies. These include: Relative Value (where Starwood ranks 14 out of 100), Intrinsic Value (12 out of 100) and combined Value-Momentum (30 out of 100). All these indicators warn investors that Starwood may struggle as it tries to outperform other US stocks.

NEWMONT MINING CORP. (NEM.N)
In contrast, investors may find Newmont Mining’s valuation more appealing after evaluating its book value using this new measure. In the chart below, the trailing 12-month P/B ratio stands at around 2.0x, or about 21% below the forward 10-year median and 46% below the highest P/B ratio recorded during the past decade.

Chart 2: NEWMONT MINING PRICE/BOOK

The company has only about $335 million of goodwill on its balance sheet, but $27.47 billion of book value. Applying the Tangible P/B model to Newmont’s balance sheet gives us a reading of 2.0x, a level that is in line with the basic P/B ratio.

As with its StarMine peers among gold mining stocks, Newmont has a low Analyst Revisions Model rank of only14 out of a possible 100; this reflects the fact that analysts currently are lowering their revenue and earnings estimates for gold mining companies. The market seems already have factored those downward revisions into their view of Newmont’s stock price, which has fallen to a level that is 30% below its November 2012 high of $72.42 a share. Other StarMine models rank Newmont as inexpensive. Its Relative Valuation Model rank (78 out of 100 – a new10-year high) and Intrinsic Valuation Model rank (80 of 100 – also almost a 10-year high) provide additional corroboration that the stock is inexpensive. In these models, low scores identify “expensive” stocks; “inexpensive” stocks post higher scores. Companies that these rankings identify as being ‘cheap’ can continue to send that signal for a while; still, patient investors are likely to find that heeding them pays off over time.
Learn more about how StarMine analytics can help you pinpoint critical developments in your portfolio or watch list. Request a free trial today.

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