Left Behind in Rally, 21% of Russell 3000 Trades Below Book

(Bloomberg) -- Take a peek under the hood of the Russell 3000 Index and in one way it looks more like it’s in a bear market than the bull that has been raging since March.

About one in five companies within the benchmark still trades below book value, even with the index hovering near all-time highs. Before the pandemic, the number had only been higher during the depths of major market routs over the past 25 years.

It’s the latest sign of how uneven the stock market’s recovery has been since the index plunged 35% to a low in March. The discounted valuations signal that many investors remain concerned that a lot of companies may not recover from the coronavirus pandemic anytime soon.

“This is emblematic of our K-shaped recovery,” Georgetown University finance professor James Angel said. “Some companies like Big Tech are doing well and pulling up the broad market-cap weighted indices. However, large swaths of the economy are still hurting very badly. Anything related to crowds or travel -- restaurants, hotels, airlines, theme parks -- is suffering.”

During a market rout, it’s not uncommon for pessimistic investors to push companies’ market capitalizations below their book value, a measure of assets minus liabilities. What’s striking in this case is how many companies remain below book value even after a full recovery from the bear market earlier this year. The rally has swollen valuations for other companies, pushing the entire index to more than 3.6 times book, near the highest since the dot-com bubble.

Among the 633 companies in the Russell 3000 that are trading below book are household names like Carnival Corp., Cinemark Holdings Inc., Goodyear Tire & Rubber Co., Macy’s Inc. and Lions Gate Entertainment Corp., according to data compiled by Bloomberg.

The figure is down from a high of 948 at the end of the March quarter but still almost double the 321 companies trading at a discount to book when the year began.

At the very least, trading at a discount to book value may be a sign that there has been substantial impairment in the value of a company’s assets. Yet it can also mean the market no longer see a viable business model at play.

“I wouldn’t be surprised if there are some companies that are going to struggle to get back to pre-pandemic levels,” UBS equity strategist David Lefkowitz said. Covid-19 has permanently altered some businesses with the acceleration of digital trends -- a phenomenon some companies have found easier to adapt to than others, he said. “There may be a subset of companies that have a really hard time recovering.”

While a price-to-book ratio can provide a meaningful reference point, many investors pay it less mind these days. Some high-tech companies tend not to own a lot of assets, which inflates their valuation under this metric. And Citigroup mid-cap analyst Scott Chronert said his firm has steered away from it since the 2008 financial crisis, when the need for companies to write down the value of assets distorted its usefulness. As such, when looking for buying opportunities, it’s important to consider both company- and sector-specific explanations for a low ratio, Chronert said.

The two sectors with the most companies priced below book are financials and energy. Within those industries, most should be able to cleanly recover along with the global economy, Chronert said. But for others, the concern is greater.

“The shutdown around the pandemic is going to end up teaching us a lot about different companies and their responses,” Chronert said. “You’re going to have companies that haven’t been able to restructure or have been unwilling to.”

©2020 Bloomberg L.P.