I was going to title this piece “The Idiocy Of The Press” or something like that. I was making my judgment on an Associated Press story I read in The Boston Globe. However, to link to the story, I wanted to use another source because of The Boston Globe‘s subscription paywall. I found the “same:” story on CBS News. However, the CBS News story had content that had been edited out of The Boston Globe story.
The Boston Globe story was headlined Bank of America draws some investors. The two paragraphs that caused me to blow my stack were:
Other investors are enticed by the low price of the stock. At around $6 a pop, the shares of Bank of America are the cheapest among large U.S. banks. Goldman Sachs Group Inc. trades above $90.
“Bank of America right now is very, very cheap,” said Thomas Brown, CEO of hedge fund Second Curve Capital, who has been buying the stock in recent months.
Nobody knowledgeable about stocks would write this in an article. When investment experts say a stock is cheap, they don’t mean it is cheap because it is $6 whereas the stock in some other company is $90. The stock price is completely arbitrary when comparing two different companies. Each company decides independently how many shares of their stock to put on the market. Therefore, if the companies have vastly different numbers of shares and the sizes of the companies are vastly different, there is no information in the stock price of one compared to the stock price of another.
When I read the article Smart money is split on Bank of America on CBS News, I realized that the idiocy is in The Boston Globe business section editors.
The following paragraphs were in the CBS News version of the Associated Press story, but were not in The Boston Globe version based on the same Associated Press story.
Bill Smith, the CEO of Smith Asset Management, also thinks the stock is cheap. Smith believes the stock lost more than what the whole business is worth. “Its parts are worth more than the whole,” Smith said.
The best measure of how investors’ value a company is market capitalization. Bank of America’s market cap now is $57 billion. However, that’s just a fourth of the bank’s “book” value, a measure that investors like Smith watch closely. Book value is the value of a company’s assets if it were to be liquidated. That value, calculated from the bank’s balance sheet — assets minus liabilities — is $230 billion.
Currently, stocks in the S&P 500 trade at almost twice their book value. While many other banks are also trading below book value currently because of worries about the economy, the gap at Bank of America is the worst among the large banks.
That valuation gap has led to market speculation that Bank of America could be forced to spin off its more profitable brokerage and investment banking operations under Merrill Lynch and put its troubled Countrywide unit into bankruptcy.
These paragraphs recognize the validity of my complaint above. You cannot tell if a stock is cheap just by looking at its price per share. You have to look at a lot more information before you can tell if $6 is a cheap price for Bank Of America stock. You have to multiply the stock price times the number of shares outstanding to get the company’s market capitalization. Even then you don’t have something to compare to another company. You have to compare the market capitalization (the value the stock market says the company is worth) with some other way of measuring its value. In this case, one analyst used the book value. When you compare two measures then you start to get an idea of whether or not the stock is cheap. There are many measures of value other than book value. If it were as simple as only comparing two measures of value for a company, there would be no disagreement between the investors who think the stock is cheap and the investors who think it is too expensive.
Of course it is possible that these paragraphs were not in the Associated Press story when The Boston Globe received it and went to press. Perhaps the CBS News story is based on a later version from the Associated Press. Both The Boston Globe story and the CBS News story are available online and could be based on the latest versions from the Associated Press. It is probably too much to expect that once The Boston Globe writes a story and posts it, that they will keep a constant eye on it in case there are updates to the story.
If I have failed to convey the problem, we can put it in simpler terms. Suppose a baker makes two equal sized pies that are as exactly alike as possible. The baker cuts one pie into 20 slices and the other pie into 10 slices. If the price of the smaller slice is $1.00 and the price of the larger slice is $1.50, is the price of the smaller slice cheap? It isn’t if you look at the price per ounce as opposed to the price per share (slice).
The complexity of determining value can also be compared to a boat navigation problem. If you measure the direction of a boat on a line from one landmark to the boat, you can draw a line on a chart and know the boat is somewhere on that line, but you don’t know where. If you get a direction form another land mark and draw that line on a chart, then you can say the boat is at the intersection of the two lines. There is some error in knowing the exact direction of either line if you are using a compass. To be absolutely sure, you can plot a line from a third landmark. Chances are that the intersections of the three lines will not be exactly in the same place. This gives you a measure of the uncertainty in your location.
Depending on how certain you need to be about your location (am I near a hidden rock, or am I approaching Boston), you may or may not need to take more measurements.