What's wrong with this picture?
When a company is selling at low price-to-earnings ratio, it is usually safe to assume that the market has sufficiently discounted the future. Specifically, the market likely foresees significant decline in the earnings and earnings power.
If the same company is also selling for half the book value, then it can be assumed that market foresees future events to harm the balance sheet, either through major losses and/or significant negative cash flow.
If the market is right about the valuing the company at low price-to-book ratio, then the debt holders of the organization can also be expected to suffer a loss. Consequently, the debt holders should be expected to demand a higher premium from the company, in the event of a default.
However, that is not entirely the case in Canam Group's (TSE:CAM) situation-- the first two arguments are true, but not the third.
Canam is currently selling for under 5 times average earnings. This business is also available in the market at more than 50% discount to book value. However, the debentures (traded on the Toronto Exchange under the symbol CAM.DB) are hardly below par, while the stock has dropped significantly during the same time.
This can only mean that Mr. Market is overreacting to the recent bad news (i.e. dividend suspension) on the equities front, but is relatively calm on the fixed income front. The debt holders must not be actually worried about the balance sheet, otherwise they would have sold off the debentures to discount the expected future. Hence, the low price-to-book valuation on the common stock is likely due to short term irrationality rather than anything else.
As a value investor with a longer term horizon than the market, this sort of inconsistency can be an opportunity for significant gains in the near future.
Disclosure: I am an owner of Canam Group at the time of this writing.
