Can someone please explain why: when the present value of expected future residual income is negative, the justified P/B based on fundamentals is less than 1?
A company that’s not generating sufficient income to cover its cost of capital (negative residual income) is destroying value. Becuase the company is not earning its cost of capital, its share price should fall and it should trade at a discount relative to book value.
You can also think of it such that since value is being destroyed, that book value will errode over time, hence it should trade at a discount to book.
nice, thanks