Where does book value fit in?
Sometimes, I hate when I think too deeply into theory behind stock value. Usually when I buy a company, it is cheap based on P/E, cheaper P/E than worse companies in the same sector, a very good company I think is in secular growth so I don't have to do a ton of analysis, a best of breed stock, or a stock where I think whatever caused the sell off is only 1/2 or less as bad as everybody else thinks. Stocks make more sense logically...they produce, while bonds dont.
Where do you fit book value into your analysis of stock price value? It is a metric I tend to ignore, unless a financial company gets way under book value since it's mostly liquid/financial assets (arguable since I am sure many banks inflate their book value).
Here is why i ask. Say you take a stock with a price of $100 and the book value is $100, and it is growing at 10% a year and the EPS is $6, for a P/E of 16.67. Let us leave out macro factors. I'm not sure what the formula is for calculating future value if you add a growth rate, but manually over 10 years it would be 6 + 6.6 + 7.26 + 7.99 + 8.79 + 9.67 + 10.64 + 11.70 + 12.87 + 14.16 = 95.68 in earnings.
Now, the reason I am going to compare this to a bond fund yielding 6% selling at par/book is because the stock reinvested all of its earnings instead of paying dividend. 6% is comparable initial return, just no growth, but I will reinvest all of the dividends into the fund to make it comparable. You could just reinvest the bond coupons into more bonds to keep it technical so I can use my main point that when you redeem a bond you get "full book value" back (aka par), but the bond fund is easier to calculate. $100 par, 10 years, 6% reinvested, gets you to a book value of $179.08, obviously not as good as the stock.
BUT, what if you looked at just P/E on stocks and not book value, like most people do. A P/E of 14 would be even cheaper, giving you EPS of $7.14 on a stock trading at $100. let's use the same growth rate here. But what if the book value is only $30? Earnings after 10 years is 7.14 + 7.85 + 8.64 + 9.50 + 10.45 + 11.50 + 12.65 + 13.91+ 15.30 + 16.83, giving you 113.77 in earnings, + 30 dollar book value is 143.77. If you "redeemed" your stock the way you "redeemed" your bonds, you would be about 30% richer in a 10 year period with the bond than with the low book value stock, even though the stock had a 10% growth rate and a higher earnings yield than the bonds yield.
So, do you use book value at all, if so where does it fit in? I never do, but maybe I should start