A company's book value is the worth of all their assets. If its stock value is less than its book value, does that mean its business is worthless and bankruptcy is imminent?
This is a followup to my previous question, What could cause a stock to trade below book value?
No, but it is certainly a possibility.
the efficient market hypothesis would say that this means that the market perceives the present value of all future earning as negative.
These earnings might take the form of a writedown of assets at some point. (Companies carry a goodwill asset that is generally imaginary. They book that asset when they buy companies for more than they are worth.)
It would be as if PRUN was a stock tracking my life. If I bought my house in 2006 for $1 million cash. I might have a book value of $1 million. However, PRUN might trade at $500k because the market knows that my asset isn't really worth $1 million and at some point my earnings will take a hit to reflect that.
It might also mean that future "real" earnings "ie actual profit and loss on sales" are going to be negative. This would mean bankruptcy is more likely.
An answer can be found in my book, "A Modern Approach to Graham and Dodd Investing," p. 89, by yours truly.
"If a company has no sustained cash flow over time, it has no value...If a company has positive cash flow but economic earnings are zero or less, it has a value less than book value and is a wasting asset. There is enough cash to pay interim dividends, but the net present value of the dividend stream is less than book value."
A company with a stock trading below book value is believed to be "impaired," perhaps because assets are overstated. Depending on the situation, it may or may not be a bankruptcy candidate.
