A longish paper explaining why using “price to book” as a metric for value can lead you astray:
Negative Equity, Veiled Value, and the Erosion of Price-to-Book
Book value doesn’t include intangible assets like brand and R&D, two increasingly important assets of companies. It also severely undervalues their real estate holdings with aggressive depreciation timeline.
There are two groups of companies that help illustrate these growing dislocations on balance sheets. The first is the overall group of companies with negative equity and the second is a group we will call “Veiled Value” stocks, which are companies that rank in the most expensive 33% by price-to-book but the Cheapest 33% by other valuation metrics. Think about Veiled Value stocks as the opposite of a value trap because they are companies that look expensive through the lens of price-to-book but are actually great values in disguise.
The extreme growth of these groups is a recent phenomenon. In 1988, there were only 13 companies with negative equity with a combined market cap of $15 billion (inflation adjusted) and now there are over 118 which combine to represents $843 billion dollars in market cap. Veiled Value stocks were relatively rare as well: only 60 names and a market cap of $91 billion in 1988. Today, there are over 258 representing over $3.9 trillion of market value. Put in perspective, $3.9 trillion market cap of Veiled Value stocks are larger than the market cap of the FANG stocks combined.
For value investors, some points to consider: companies with negative equity have historically outperformed the market and the Veiled Value stocks have performed even better (See Figure 2). Both groups have also outperformed very consistently over the last 25 years. Negative equity outperformed in almost 60% of rolling three-year periods and Veiled Value names in over 90%.5 An investment process that continually avoids investment in these companies is likely to suffer as a result.
Over 25 years, “Veiled Value” would get you 49x return, while “All Stocks” will only get you 16x.
It’s worth your time to read the whole paper.