AAII Investor Update: 20 Stocks Priced Below ‘Paper’ Assets
Thursday, August 16, 2012
Charles Rotblut, CFA
AAII Journal Editor

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Sentiment Survey

This week’s AAII Sentiment Survey results:
  Bullish: 36.8%, up 0.4 points
  Neutral: 35.1%, down 1.1 points
  Bearish: 28.1%, up 0.7 points

Long-term averages:
  Bullish: 39%
  Neutral: 31%
  Bearish: 30%

Take the AAII Sentiment Survey »

There are 20 stocks in the S&P 500 that are worth less than the intangible assets listed on their balance sheets. You can theoretically buy each company for less than their patents, logos, trademarks, goodwill and other “paper” assets are worth.

I was prompted to run the analysis after reading an article in The Wall Street Journal about the subject earlier this week. The article listed a few stocks that were trading below their goodwill, but I wanted to extend the analysis to include all intangible assets. Unlike a machine or a part, an intangible asset lacks physical properties and does not impact cash flow. (You can’t hold an account receivable either, but when the invoice is paid, cash does flow into the company.)

As a value investor, I pay a lot of attention to the price-to-book ratio. Not only do I want it to be below 3.0, I also want shareholders’ equity (aka, “book value”) to exceed intangible assets by a wide margin. The rationale is that a company can inflate its total assets, and thereby its book value, by assigning a higher value to its intangible assets. Many CEOs and CFOs, blinded by their optimism of both their managerial skills and their company’s prospects, assign too much value to intangible assets. This is particularly the case for goodwill, the amount paid in excess of identifiable assets for an acquisition. Since I lack the data to analyze whether a specific company’s intangible assets are overvalued or not, I incorporate a margin of safety into my personal screen by penalizing any company with intangible assets that exceed 50% of its book value. It’s a subjective percentage, but I feel better having the criteria in place.

Accounting rules do require companies to review the value of what they record on the balance sheet. For example, goodwill is subject to an annual impairment test. Microsoft (MSFT) famously alerted investors to the rule earlier this year when it took a $6.2 billion charge for its acquisition of online advertising firm aQuantive, admitting the company it bought in 2007 was now worthless. Even with these rules, legitimate questions can still be raised. For example, how much are the mobile phone patents held by Research in Motion (RIMM) or Nokia (NOK) actually worth now? When thinking of an answer, consider that any asset is only truly worth the amount a willing buyer and a willing seller agree to transact at when neither is under duress.

Many intangible assets are worth considerable amounts of money. The name “Coca-Cola” and the soda’s recipe have helped create a massive amount of profits over the years. The Yahoo! domain name remains a prime property on the Web. Microsoft’s presence in so many offices and the wide availability of software titles for Windows makes its operating system considerably valuable. But, for every intangible asset that truly does have significant value, there is an unknown number whose values are questionable.

The table below shows the 20 companies in the S&P 500 whose market capitalizations were less than the recorded value of their intangible assets, as of last Friday’s close. This discount suggests that either investors are undervaluing these companies or they think the reported value of the intangible assets is too high. Like the value of intangible assets, whether these companies are actually undervalued is a subjective call.

S&P 500 Stocks Trading at Discounts
to Intangible Value

Company Ticker Goodwill and Intangibles ($mil) Total Equity ($mil) Market Capitalization ($mil) Intangibles / Market Cap Price / Book
Sealed Air Corp SEE 6,204 2,869 2,716 228.40% 0.94
Alpha Natural Resources, Inc. ANR 3,150 5,075 1,620 194.50% 0.32
NASDAQ OMX Group, Inc. NDAQ 6,728 4,961 3,899 172.60% 0.8
Boston Scientific Corporation BSX 12,723 7,728 7,861 161.80% 1.02
NYSE Euronext NYX 9,699 6,311 6,128 158.30% 0.99
CME Group Inc. CME 27,450 21,620 17,809 154.10% 0.82
Sprint Nextel Corporation S 22,417 9,227 14,762 151.90% 1.6
Legg Mason, Inc. LM 5,112 5,456 3,478 147.00% 0.65
Hewlett-Packard Company HPQ 54,746 41,288 38,845 140.90% 0.94
L-3 Communications Holdings, I LLL 9,242 6,771 6,796 136.00% 1.01
Xerox Corporation XRX 11,752 12,010 9,386 125.20% 0.8
Windstream Corporation WIN 6,889 1,337 5,533 124.50% 4.11
WellPoint, Inc. WLP 22,661 23,644 18,832 120.30% 0.81
R.R. Donnelley & Sons Company RRD 2,761 1,061 2,297 120.20% 2.17
Fidelity National Information FIS 10,923 6,662 9,151 119.40% 1.36
Comcast Corporation CMCSA 109,280 47,731 92,505 118.10% 1.96
Molson Coors Brewing Company TAP 9,413 7,811 7,998 117.70% 1.02
Time Warner Cable Inc. TWC 29,570 7,357 27,398 107.90% 3.78
Republic Services, Inc. RSG 11,066 7,680 10,535 105.00% 1.38
BlackRock, Inc. BLK 30,379 25,303 30,179 100.70% 1.22

Source: AAII’s Stock Investor Pro and Thomson Reuters. Data as of 8/10/2012.

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AAII Model Portfolios Updated

There were no changes in either of the model portfolios during the month of July.

For July, the Model Shadow Stock Portfolio was down 1.2%. The Model Shadow Stock Portfolio underperformed both the Vanguard Small Cap fund (NAESX), which lost 0.8%, and the DFA US Micro Cap fund (DFSCX), which lost 0.9%. For the year, the Shadow Stock Portfolio is now up 9.0%, outpacing the 8.1% gain achieved by the Vanguard Small Cap fund and the 7.2% gained by the DFA US Micro Cap fund.

The Model Fund Portfolio lost 0.7% for July. This compares to the Vanguard Total Stock Market fund (VTSMX), which gained 1.0%. For the year, the Model Fund Portfolio is up 5.8%, while the Vanguard Total Stock Market fund is up 10.4%.

The Week Ahead

Approximately 15 members of the S&P 500 are scheduled to report earnings next week. Included in this group is Dow component Hewlett-Packard (HPQ), which reports on Wednesday.

The economic calendar is pretty light. July existing home sales and the minutes from the August Federal Open Market Committee meeting will be published on Wednesday. Thursday will feature July new home sales. July durable goods orders will be published on Friday.

The Treasury Department will auction $14 billion of five-year inflation protected securities (TIPS) on Thursday.

AAII Sentiment Survey

Bearish sentiment remains below 30%, as the AAII Sentiment Survey registered its first back-to-back below average readings for pessimism since April 5, 2012. Bullish sentiment also continues to be below its historical average.

Bullish sentiment, expectations that stock prices will rise over the next six months, edged up 0.4 percentage points to 36.8%. The increase keeps optimism at its highest level since April 5, 2012. Nonetheless, bullish sentiment is below its historical average of 39% for the 20th consecutive week.

Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, declined 1.1 percentage points to 35.1%. Even with the decrease, neutral sentiment is above its historical average of 31% for the third consecutive week and the seventh time out of the past nine weeks.

Bearish sentiment, expectations that stock prices will fall over the next six months, rebounded 0.7 percentage points to 28.1%. This is the second week that bearish sentiment is below its historical average of 30%.

Some AAII members remain cautiously optimistic about the short-term direction in stock prices as the market holds onto its summer gains. Bullish sentiment remains below its historical average, however, as concerns about slowing global economic growth, Washington politics, the European sovereign debt crisis and further market volatility remain very much front and center. The ongoing streak of below-average bullish sentiment is the longest since a 29-week period between April 2, 1993, and October 15, 1993.

This week’s special question asked AAII members whether this summer’s financial industry scandals (Knight Capital, Standard Chartered, Peregrine Financial Group, etc.) have impacted their sentiment toward stocks or if their sentiment is mostly impacted by macro factors (e.g., the economy, Europe, etc.) instead. Respondents overwhelmingly said their sentiment is affected by macro factors, not the recent scandals. Several respondents made the observation that the industry has long had problems, making the recent headlines more noise than anything else.

Here is a sampling of the responses:

  • “I’m more concerned about the macro factors, such as the U.S. and Europe. Investors are almost immune now to stories of financial fraud.”
  • “My sentiment is definitely impacted by macro events; however, I don’t like hearing about the shenanigans occurring at Knight Capital.”
  • “Financial scandals are interesting, but irrelevant. My sentiment depends on a comparison of the stock market’s price level versus the U.S. economy.”
  • “My sentiment toward stocks is affected more by macro factors, including the fact that financial industry scandals have become the norm.”
  • “It makes me feel the ECB will be proactive in saving the euro.”
  • “I have become more cautious in how I invest and use limit orders when buying or selling securities.”

» Take the sentiment survey

Wishing you prosperity,

Charles Rotblut, CFA
AAII Journal Editor