The price-to-economic book value (“Price-to-EBV”) ratio measures the difference between the market’s expectations for future profits and the no-growth value of the stock. Economic book value (“EBV”) is our measure of the no-growth value of a stock.
When stock prices are much higher than EBVs, the market predicts the economic profitability (as distinct from accounting profitability) of the company will meaningfully increase. When stock prices are much lower than EBVs, the market predicts the economic profitability of the company will meaningfully decrease. If the stock price equals the EBV, the market predicts the company’s economic earnings will stay the same into perpetuity.
EBV measures the no-growth value of the company based on the current Net Operating Profit After Tax (NOPAT) of the business. It is also known as the “pre-strategy value” of the company because it focuses only on the perpetuity value of the current NOPAT or cash flows.
As an example, in Blue Light Special on WMT, I explain how Wal-Mart’s valuation went from Very Dangerous in the late 1990s to Very Attractive recently. This change occurred as the stock remained flat while the cash flows (NOPAT) increased substantially. Figure 1 from my article, below, compares the EBV per share of Wal-Mart to its stock price.
The Formula for EBV is:
(NOPAT / WACC)
+ Unconsolidated Subsidiary Assets
+ Net Assets from Discontinued operations
- Value of Outstanding Employee stock option liabilities
= Economic Book Value (EBV)
EBV per share equals EBV divided by shares outstanding.
Disclosure: I have a position in WMT. I receive no compensation to write about any specific stock, sector or theme.