Letters of the Week

Calculating price-to-book value ratio, short-selling assumptions, and top-down investing by sector.

Calculating price-to-book value ratio

After a free trial I have just signed up to a yearly subscription of Eureka Report and I am delighted. Your content, insights and commentary are superb, thank you.

I am also a new investor having just taken responsibility for my own superannuation through a self-managed superannuation fund (SMSF). I read with interest Scott Dixon’s recent article, Strategies from the world’s best investor, on Bruce Berkowitz and his approach using price-to-book value ratio as a key measure. Can you suggest the most reliable method to calculate this?

Thank you in advance

SL

Editor’s response:  Thank you for your letter. The formula for price-to-book value ratio is the latest share price divided by total assets minus intangible assets and liabilities. Keep in mind that a lower price-to-book value ratio could indicate that the stock is undervalued, but it could also be an indication that there are major issues with the company.

Short-selling assumptions

In Tim Treadgold's article, Short-selling bears feast on junior miners, the second chart highlights stocks where the reported amount of stock borrowed or lent is greater than the amount of stock reported as sold short. The assumption therefore is that this "reflects stocks ready to be sold short".

Some institutions will loan large stock positions as collateral or to seize arbitrage opportunities. If borrowers are therefore taking long positions using this method, will this affect the logic of assuming the stock is ready to be sold short?

SB

Tim’s response: I suppose so, although why anyone would borrow stock to take a long position is interesting, when they could simply buy stock on the market using their own capital or a margin loan.

Top-down investing by sector

I’m interested in learning more about diversification in top-down investing. If I was to find what I thought were the 10 best companies to buy, but they were in all in the same sector, I'd be quite concerned about not being diversified. As such, I'd probably prefer to find the best company to buy in each of the, say, 10 sectors.

But here's the problem. You could weight each sector evenly and put 10% into financials, 10% into resources etc. Or, you could see that financials make up 35% of the market and hence place 35% of your funds into financials - the supposed benefit would be that you wouldn't over invest in Australia's smallish sectors like IT.

I'm interested in hearing the different arguments about the appropriate weightings to apply to each Australian sector. For example, if there is an optimal weighting for financials (in terms of diversification, correlation etc) somewhere between the 10% and 35% mentioned above.

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