Tidbit: Why the ratio is misleading
Jim Jubak writes (2 Nov 07):
The trouble is, book value doesn’t tell an investor much when companies are busy writing down the value of the assets they hold on their books. For example, for the third quarter, Pulte wrote down the value of the land it holds by $1.2 billion. That’s more than 10% of the company’s book value. Mortgage lender Countrywide wrote down the value of mortgages and recorded losses on the sale of mortgages and mortgage-related assets by $1 billion in the third quarter. That’s about 4% of the company’s book value. Any investor thinking these stocks are bargains now because the price-to-book-value ratio is so low is betting that the write-downs are over. It’s likely, though, that we’re a long way from the end of the write-downs.
Home-builder CEOs are now calling for the housing market to bottom in 2009, and debt-rating companies such as Moody’s (MCO, news, msgs) are issuing daily credit downgrades of mortgage-backed assets. Moody’s has downgraded $50 billion in mortgage-backed securities in the past few months and warned Oct. 26 that more downgrades were on the way. On Oct. 29, Moody’s competitor Fitch Ratings put $24 billion in mortgage-backed debt — and low-risk AAA-rated debt at that — on credit watch.
Price-to-sales ratios, another traditional bargain hunter’s tool, are similarly misleading right now. What do home builders Pulte, Centex, Lennar, D.R. Horton (DHI, news, msgs), KB Home (KBH, news, msgs) and Ryland Group (RYL, news, msgs) have in common? They all show up on a bargain-hunting screen with attractive price-to-sales ratios. These stocks sport price-to-sales ratios of 0.31 to 0.33, and a ratio below 1 traditionally signifies a bargain. Of course, with sales falling like a stone, their ratios could be even lower in the next quarter.
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