Not heading for the exits (yet)

Today’s chart shows the S&P 500 trading at 5.3x book value – the highest level since WWII. Many investors question how useful book value still is as a yardstick. With the rise of technology and services, businesses have become less capital-intensive, while years of M&A have filled balance sheets with goodwill and other intangibles that are hard to value.

At ECP we share the view that book value on its own is a poor guide. It can make markets and companies look cheap on paper while they generate little or no cash. What matters is the earning power that sits on top of that equity. Think of a hotel in a bad location that needs heavy renovation: it might trade at a big discount to its historical book value and still be a terrible investment.

So while US markets are certainly trading on the high side in terms of valuation, this graph alone does not make us head for the exits.