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295/8 125/8 2615/16 261/2 269/16 1
PentonMedia + /16
PME .12 .5 51 352
3915/16 281/2 291/4 281/8 283/8 5
PeopEngy “ /8
PGL 2.00f 7.0 10 681
215/8 51/2 515/16 51/2 57/8 1
PepBoys + /4
PBY .27 4.6 12 5488
n 251/4 151/2 187/16 171/8 17/16
PepsiBttlng 23 11097 17 “
PBG .08 .5
111/16 41/2 51/16 43/4 415/16 1
PepsiGem GDR ... 394 + /8
GEM j ...
61/16 33/16 39/16 35/16 31/2 1
PepsiAM B dd 297 + /8
PAS j ...
411/2 301/8 343/8 333/16 3
PepsiCo 25 35998 34 “ /16
PEP .54 1.6
841/2 251/2 697/8 641/2 653/16 31/2
PerkinElmer 56 4568 “
PKI .56 .9
61/8 33/4 413/16 41/2 41/2
PermRltyTr ... 76 ...
PBT .47e10.4
437/16 155/16 253/4 261/4 7
PerotSys A 39 3050 27 “ /8
PER ...
131/2 415/16 71/8 65/8 1
PrsnlGpAm 7 1637 7 + /8
PGA ...
173/8 103/8 141/16 137/8 141/16 1
PetroCnda g ... 58 + /16
PCZ .40g ...
367/8 281/4 321/16 313/4 313/4 1
PeteRes ... 146 “ /4
PEO 2.20 6.9
243/8 111/16 163/4 161/4 169/16 11
PeteGeoSvc cc 4250 + /16
PGO ...
23/16 13/32 11 5 11
PetsecEngy dd 219 /16 /8 /16 ...
PSJ ...
511/4 23 471/8 451/2 13/8
PfeiffrVac ... 99 47 “
PV .30e .6
s 5011/256 30 335/16 329/16 331/16 1
Pfizer 40 92866 + /16
PFE .36f 1.1
811/16 35/8 45/16 41/16 41/4 1
PharmRes dd 320 + /8
PRX ...
663/8 423/4 487/8 473/16 481/2 7
31 32566
PharmUpjhn “ /16
PNU 1.00 2.1
73 4511/16 519/16 485/16 4813/16 211/16
dd 4968
PhelpDodg “
PD 2.00 4.1
n 259/16 193/4 203/16 1915/16 201/8 1
... 129 /8
PhilAuthInd “
POB 1.64 8.1




The column headed “Vol 100s” shows that the trading volume in PepsiCo was
35,998 round lots. Each round lot is 100 shares, so 3,599,800 shares of PepsiCo traded
on this day. A trade of less than 100 shares is an odd lot.


Explain the entries for People™s Energy in Figure 3.11.
Self-Test 1


Book Values, Liquidation Values,
and Market Values
Why is PepsiCo selling at $34 per share when the stock of Pfizer, listed below PepsiCo,
is priced at $331„16? And why does it cost $25 to buy one dollar of PepsiCo earnings,
while Pfizer is selling at 40 times earnings? Do these numbers imply that one stock is
a better buy than the other?
Finding the value of PepsiCo stock may sound like a simple problem. Each year Pep-
siCo publishes a balance sheet which shows the value of the firm™s assets and liabilities.
The simplified balance sheet in Table 3.2 shows that the book value of all PepsiCo™s as-
sets”plant and machinery, inventories of materials, cash in the bank, and so on”was
$22,660 million at the end of 1998. PepsiCo™s liabilities”money that it owes the banks,
taxes that are due to be paid, and the like”amounted to $16,259 million. The difference
between the value of the assets and the liabilities was $6,401 million, about $6.4 billion.
This was the book value of the firm™s equity.4 Book value records all the money that
Net worth
BOOK VALUE
PepsiCo has raised from its shareholders plus all the earnings that have been plowed
of the firm according to the
back on their behalf.
balance sheet.

4 “Equity” is still another word for stock. Thus stockholders are often referred to as “equity investors.”
284 SECTION THREE


TABLE 3.2
BALANCE SHEET FOR PEPSICO, INC., DECEMBER 26, 1998
(figures in millions of dollars)
Assets Liabilities and Shareholders™ Equity
Plant, equipment, and other assets 22,660 Liabilities 16,259
Equity 6,401

Note: Shares of stock outstanding: 1,471 million. Book value of equity (per share): $15.40.



Book value is a reassuringly definite number. KPMG, one of America™s largest ac-
counting firms, tells us:
In our opinion, the consolidated financial statements . . . present fairly in all material
respects, the financial position of PepsiCo Inc. and Subsidiaries as of December 26, 1998
and December 27, 1997, and the results of their operations and their cash flows for each of
the years in the 3-year period ended December 26, 1998, in conformity with generally
accepted accounting principles.

But does the stock price equal book value? Let™s see. PepsiCo has issued 1,471 mil-
lion shares, so the balance sheet suggests that each share was worth $22,660/1,471 =
$15.40.
But PepsiCo shares actually were selling at $33.94 at the end of 1998, more than
twice their book value. This and the other cases shown in Table 3.3 tell us that investors
in the stock market do not just buy and sell at book value per share.
Investors know that accountants don™t even try to estimate market values. The value of
the assets reported on the firm™s balance sheet is equal to their original (or “historical”)
cost less an allowance for depreciation. But that may not be a good guide to what the firm
would need to pay to buy the same assets today. For example, in 1970 United Airlines
bought four new Boeing 747s for $128 million each. By the end of 1986 they had been
fully depreciated and were carried in the company accounts at residual book value of
$200,000 each. But actual secondhand aircraft prices have often appreciated, not depre-
ciated.5 In fact, the planes could have been sold for upwards of $20 million each.
Well, maybe stock price equals liquidation value per share, that is, the amount of
LIQUIDATION VALUE
cash per share a company could raise if it sold off all its assets in secondhand markets
Net proceeds that would be
and paid off all its debts. Wrong again. A successful company ought to be worth more
realized by selling the firm™s
than liquidation value. That™s the goal of bringing all those assets together in the first
assets and paying off its
place.
creditors.
The difference between a company™s actual value and its book or liquidation value is
often attributed to going-concern value, which refers to three factors:
1. Extra earning power. A company may have the ability to earn more than an adequate
rate of return on assets. For example, if United can make better use of its planes than
its competitors make of theirs, it will earn a higher rate of return. In this case the
value of the planes to United will be higher than their book value or secondhand
value.
2. Intangible assets. There are many assets that accountants don™t put on the balance
sheet. Some of these assets are extremely valuable to the companies owning or using
5 This
is partly due to inflation. Book values for United States corporations are not inflation-adjusted. Also,
when the accountants set up the original depreciation schedule, nobody anticipated how long these aircraft
would be able to remain in service.
Valuing Stocks 285


TABLE 3.3
Book Value Ratio:
Market versus book values,
Firm Stock Price per Share Price/Book Value
August 1999
Amgen 77.31 5.41 14.3
Consolidated Edison 42.88 26.80 1.6
Ford 51.44 23.38 2.2
McDonald™s 42.00 6.77 6.2
Microsoft 85.00 4.91 17.3
Pfizer 34.75 2.20 15.8
Walt Disney 29.19 10.06 2.9


Source: http://finance.yahoo.com.



them but would be difficult to sell intact to other firms. Take Pfizer, a pharmaceuti-
cal company. As you can see from Table 3.3, it sells at about 15.8 times book value
per share. Where did all that extra value come from? Largely from the cash flow gen-
erated by the drugs it has developed, patented, and marketed. These drugs are the
fruits of a research and development (R&D) program that since 1985 has averaged
about $500 million annually. But United States accountants don™t recognize R&D as
an investment and don™t put it on the company™s balance sheet. Successful R&D does
show up in stock prices, however.
3. Value of future investments. If investors believe a company will have the opportunity
to make exceedingly profitable investments in the future, they will pay more for the
company™s stock today. When Netscape, the Internet software company, first sold its
stock to investors on August 8, 1995, the book value of shareholders™ equity was
about $146 million. Yet the prices investors paid for the stock resulted in a market
value of over $1 billion. By the close of trading on that day, the price of Netscape
stock more than doubled, resulting in a stock market value of over $2 billion, nearly
15 times book value. In part, this reflected an intangible asset, the Internet browsing
system for computers. In addition, Netscape was a growth company. Investors were
betting that it had the know-how that would enable it to devise successful follow-on
products.

Market price need not, and generally does not, equal either book value or
liquidation value. Unlike market value, neither book value nor liquidation
value treats the firm as a going concern.

It is not surprising that stocks virtually never sell at book or liquidation values. In-
vestors buy shares based on present and future earning power. Two key features deter-
mine the profits the firm will be able to produce: first, the earnings that can be gener-
ated by the firm™s current tangible and intangible assets, and second, the opportunities
the firm has to invest in lucrative projects that will increase future earnings.


Consolidated Edison and Amazon.com
EXAMPLE 1
Consolidated Edison, the electric utility servicing the New York area, is not a growth
company. Its market is limited and it is expanding capacity at a very deliberate pace.
286 SECTION THREE


More important, it is a regulated utility, so its profits on present and future investments
are limited. Its earnings have been growing slowly, but steadily.
In contrast, Amazon.com has little to show in the way of current earnings. In fact, by
September 1999, it had recorded accumulated losses of over $500 million. Neverthe-
less, the total market value of Amazon stock in March 2000 was $22 billion. The value
came from Amazon™s market position, its highly regarded distribution system, and the
promise of new related products which presumably would lead to future earnings. Ama-
zon was a pure growth firm, since its market value depended wholly on intangible as-
sets and the profitability of future investments. It is not surprising then that while Con
Ed shares sold for less than their book value in March 2000, Amazon sold for 53 times
book value.


Financial executives are not bound by generally accepted accounting principles, and
they sometimes construct a firm™s market-value balance sheet. Such a balance sheet
MARKET-VALUE
helps them to think about and evaluate the sources of firm value. Take a look at Table
BALANCE SHEET
3.4. A market-value balance sheet contains two classes of assets: (1) assets already in
Financial statement that uses
place, (a) tangible and (b) intangible; and (2) opportunities to invest in attractive future
the market value of all assets
ventures. Consolidated Edison™s stock market value is dominated by tangible assets in
and liabilities.
place; Amazon™s by the value of future investment opportunities.
Other firms, like Microsoft, have it all. Microsoft earns plenty from its current prod-
ucts. These earnings are part of what makes the stock attractive to investors. In addition,
investors are willing to pay for the company™s ability to invest profitably in new ven-
tures that will increase future earnings.
Let™s summarize. Just remember:
• Book value records what a company has paid for its assets, with a simple, and often
unrealistic, deduction for depreciation and no adjustment for inflation. It does not
capture the true value of a business.
• Liquidation value is what the company could net by selling its assets and repaying
its debts. It does not capture the value of a successful going concern.
• Market value is the amount that investors are willing to pay for the shares of the firm.
This depends on the earning power of today™s assets and the expected profitability of
future investments.
The next question is: What determines market value?


In the 1970s, the computer industry was dominated by IBM and was growing rapidly.
Self-Test 2
In the 1980s, many new competitors entered the market, and computer prices fell. Com-
puter makers in the 1990s, including IBM, struggled with thinning profit margins and
intense competition. How has IBM™s market-value balance sheet changed over time?
Have assets in place become proportionately more or less important? Do you think this
progression is unique to the computer industry?

TABLE 3.4
A MARKET-VALUE BALANCE SHEET

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