Benjamin Graham, the father of value investing, once described his strategy as "buying dollars for 50 cents." He would have loved this market.
Graham had several tricks to determine whether a company was undervalued. One of them was assessing its book value, a figure that can be found on any company's balance sheet. In fact, book value, or shareholder equity, provides the balance on a balance sheet: It's the difference between the company's assets and its liabilities. To determine a company's book value, an investor simply divides shareholder equity by the number of shares outstanding.
Graham was a stickler on this point. In his "Last Will and Testament," a piece published in Forbes after his death, one of the commandments mandated a stock price down to two-thirds of book value. In other words, Graham was willing to pay as much as 66 cents on the dollar -- though that was as high as he'd go.
Three members of the Dow Jones Industrial Average trade for less than the book value. This is best represented by the price to book value ratio, wich divides a company's stock price by its per-share book value.
Here are the three Dow stocks that have a P/B below 1:
Alcoa (NYSE: AA)
Alcoa is the largest U.S. aluminum producer. The company's aluminum can be found in anything from canned food to cars.
From an asset standpoint, the market values Alcoa at 88 cents on the dollar. That's cheap, but it has more to do with earnings quality than asset quality. Alcoa hasn't been profitable for the past three quarters because of falling aluminum prices brought on by the economic crisis.
Though Travelers' shares are trading at a lower valuation than the Dow, they don't offer much of a discount, only -7% off. What's more, its earnings multiple is 8.9 vs. a two-year average of 7.5. This suggests there is limited upside.
Bank of America (NYSE: BAC)
I know banks have had it rough lately, but how would you like to own one for -39% off? That's what you're getting with Bank of America.
The numbers show investors are paying 61 cents for irery dollar of the bank's assets. This valuation is the lowest in the Dow by a mile, though there are a lot of other banks out there that are selling for far less. One difference, though: Bank of America reported a profit of 25 cents a share in the second quarter and is expected to earn 53 cents a share for the year.
It's the largest bank in the U.S., it's profitable, and investors who buy now get all that for free. All they pay is 61 cents on the dollar for assets. It's earnings outlook? There isn't a single investor on Wall Street who doesn't think Bank of America's earnings are going to come back. That's why it's trading at 139.5 times its trailing earnings.
Alcoa, as a basic materials company, isn't likely to see its shares take off until a real bull market is peaking. We're a long way from that.
Travelers is fairly valued.
That leaves Bank of America. It has a historical average of 1.2 times book value, which puts its fair value at $27.25, a +78% gain from this morning's open.