Book value. It’s such a simple accounting calculation, but it’s perhaps the most critical Micron (NASDAQ: MU) that investors can do. Over the decades, Micron’s stock has been on a rollercoaster ride, moving almost congruently but upward through stock market cycles. And this roller coaster got on the way to book value. Like clockwork, an investor can buy Micron at the low end of this valuation metric, relax, and wait for envious CAGR returns. And this week, the stock has plunged as close to book value as it has in the past few years, and Micron investors who have been in the stock for a while, like me, are waiting like a child for Christmas to put their next tranche of investment money for five years to work.
Now, if you’re new to the world of Micron motion sickness, you quickly think, “How could anyone think of getting into Micron when there’s blood on the streets all over the market?” Yes, that sounds scary, but there are a few things to get your feet wet before we jump into an “automatic” purchase at book value.
The valuation measure of the price-to-book ratio is not without surrounding circumstances. The market does not operate in a vacuum when it comes to Micron’s earnings or its medium-term future. The reason Micron is less than 10% of book value is not devoid of the weighing machine that is on the market. But when taken over the years, this swing from book value to a relatively unknown higher P/B value to book value doesn’t mean the stock isn’t at ground zero every cycle on the graphic. On the contrary, growing Micron’s book value from a P/B of one to a P/B of one over the years pays a curiously high return.
In short, an investment in Micron is an investment in the assets of the company.
And because Micron’s modern-day management team has focused on cutting the company’s costs while strengthening its balance sheet, its assets have been on an upward trajectory like never before in Micron’s history. the company.
Book value provides the market safety net
You may recall from my last post on Micron, where I discussed their guide down in their pre-announcement for Thursday’s report. In it, I said that the reductions in earnings estimates would start to form a bottom, but that wasn’t there and there, just that the process was well underway. The point of the article was that now was not the time to sell, but now was not the time to buy, at least not yet. However, the bottom was closer than farther, I postulated, as the estimates were greatly reduced, a requirement for finding a bottom in the Micron cycle history.
This turned out to be correct as the book value is now within the range of the limit order.
I expect Thursday’s earnings report to further accelerate this process, aligning analysts with management’s near to medium-term outlook.
But, in the meantime, the market took its usual liberty to drive down Micron’s valuation ahead of the actual bottom. Anyone who reads my articles knows that I frequently mention the two to three quarter outlook the market is looking at, especially for memory players like Micron. This means that it sniffs the low before the actual financial bottom while sniffing the high before the financial top.
So, while earnings estimates are sharply reduced for the coming quarters, the market is already pricing this in, which is how we arrive at the chart below.
Now, I agree that using book value is obsolete because the market uses it to indicate what the company is worth if it goes bankrupt. Micron is in no danger of going bankrupt today; these were concerns in the early 2000s and into the mid-2000s, when its technology was generations behind and its balance sheet was not pretty and debt-laden. Today, Micron’s balance sheet is pristine with $5 billion in net cash, a dividend and share buybacks. Micron is also the first to market the latest market node for DRAM and NAND.
Micron has never been in a better position.
That said, it is the old guard of the market when it comes to valuing Micron as it cannot master cyclicality with enough predictability. It’s always about higher and higher estimates when things are going well and lower and lower estimates when things are going badly. For all its flaws, book value helps investors like us see the bottom of the valuation, regardless of earnings.
And, if the market is going to use book value to his advantage, I will use it for my advantage.
So about these book to book returns
Looking at the chart above, you might think that the lows at the end of 2018 mean that the stock is now back to 2018 levels. However, you wouldn’t be more wrong.
The stock fell to $28.23 during the low period of 2018, when it very briefly fell below book value, which means that if the company returns to book value of $44 (I’m expect book value to be $45 per share after Thursday’s report), the yield is 56%. That’s a CAGR of over 12.5% between December 2018 and today.
In other words, the worst you would have done would be a 56% gain in less than four years buying at book value. This is the minimum because Micron’s book value looks like this over this period:
You might be thinking now, “Joe, you didn’t factor in Micron’s current or future earnings or a decline in book value.” Micron’s assets include the accumulation of its asset portion of its balance sheet and the repayment of debt over time. This is how Micron went from being deeply net debt to being net cash positive.
But on a more practical level, Micron’s earnings allow it to continue to build its balance sheet and therefore its book value over the years. Sure, the book value might slow during low income periods, but I’m talking about a bottom-to-bottom move. By the time the single book value presents itself next time, the peak part of the cycle will have occurred, and this is where the book value increases dramatically.
And for those times when the business isn’t doing well because the memory sector is taking a hit due to supply and demand, the chart above shows pretty clearly that the book value has continued to rise. evolve even during the weakest periods.
Risks and book value calculations
Now, that’s not to say the book value can’t go down, and so the goal post moves, but Micron’s book value hasn’t gone down significantly in the last ten years. And it won’t as long as the business maintains at least positive free cash flow for the year, eliminating any need to use cash on hand to operate the business or go into endless debt.
Even in the face of its worst times over the past decade, book value can barely be seen to decline between 2015 and 2017. This was also when the balance sheet was at its worst with toxic convertible debt instruments. But since 2017, the book value has steadily increased with massive increases during the best times.
The beauty of this assessment is that the calculation is simple to do on an ongoing basis – which I will do on Thursday when the report comes out. Just look at the balance sheet and find the line for total assets and the line for total liabilities. Then you subtract the total liabilities line from the total assets line to get the book value of the business. Using the FQ3 revenue report, this equates to $49,281 million ($49.3 billion) ($65,296 million to $16,015 million).
Then you divide by the total shares outstanding to get the book value per share (meaning share buybacks help here). At FQ3, Micron has 1.121 billion shares outstanding, giving it a book value per share of $44. If Micron increases its book value by $1.2 billion in the current quarter, it will reach $45 per share. It increased by $1.44 billion in FQ3 compared to FQ2. With the painful predictions for FQ4, my estimate of $1.2 billion may not be reached, but it should reach at least $1 billion, depending on the timing of some equipment payments and the current line of debt.
Win, lose or draw
Regardless of the negative outlook for Micron over the next two or three quarters, the valuation that the market has chosen to price the stock has the advantage of giving us a floor for the stock. That doesn’t mean the stock can’t fall below book value, as it has in the past, but it is very fast and minimal. Given the strength of modern-age business, the market has no reason to award it the price of bankruptcy. But when it does, that has proven to be the best time to buy stocks.
It all boils down to the fact that Micron shares are valued just 11% above book value at Wednesday’s close. In other words, there’s only a 10% decline with the worst financials yet to come on Thursday – meaning the market is ahead of the news. Risk versus reward couldn’t be clearer for the stock market cycles Micron experiences.