In this series of articles we will provide some insight into how we value the companies that we select in our Renting Shares, Protected Equity and Credit Spread Portfolios.

In Part 1 of this series we described that Value Investing was about determining the value of a stock and then assessing whether it was sufficiently below ‘your’ price to buy it.  We also talked about the gentleman that introduced the concept, Ben Graham, and the students of his teachings such as Warren Buffet.  Lastly we talked in general terms about the components of Value Investing.  In this article we will discuss the importance of assessing Asset Value and Quality as a component of building up a base to determine a company’s worth.

What do we mean by Assets?

Assets are the engine of a company’s valuation and can be classified as Tangible or Intangible.  Tangible assets think of property, plant and equipment (e.g. machinery, land and buildings) and Intangibles think of licences and brand names (e.g. the brand name Coke).  Neither class of asset is better than the other.  It’s worth noting though that some of the top companies have very little in the way of tangible assets.

In order to gauge the quality of a company’s assets you need to understand what it is the company does and whether those assets are suitable to support the ongoing generation of income.

The average investor will be at a disadvantage here as we can’t go out and look at a company’s factory but we can read Broker Reports.  However you can make your own judgement sometimes.  For example, you can easily look at a Retailers’ stores and make your own assessment on whether they are running well and whether they will need improvements (capital expenditure) to the presentation of their shops.  You may look at this and think wow, these are really run down and are low quality compare to the competition.  If you look at the company and it doesn’t have much cash or ability to raise funds that might be a negative.  Mind you this is only one aspect and should be considered with all the components of valuing the company.

Why are they important?

The value of a company’s assets on its balance sheet is an important measure to determine the floor value or liquidation value of a stock.  In general terms it is unlikely a stock will decrease to below its net tangible asset value.  Assuming those assets are valued correctly, which seems to becoming more common, but we will leave that one for later.

The quality of a company’s assets is important because it can answer all sorts of questions like competitive advantage, growth potential, surplus assets for potential divestment, inventory turnover and capital expenditure requirements.

What are the factors to look for when assessing Assets?

The Balance Sheet of a company can provide us with lots of quantitative information and we can calculate a myriad of financial ratios.  These are important and we will go through these in about Part 4 of this series but for this article want to focus on the Qualitative measures.  That is, the non financial aspects that can really influence our investment decision.  There is no exhaustive list of questions but here are some to get you started:

Type of assets: Are the assets fit for their purpose? 

Condition of assets: What condition are the assets in?  Will they need a large amount of capital expenditure in future years?

Location of assets: Are they close to customers? Are they close to suppliers? Do shipping costs make a difference?

Valuation of assets: Have the assets been re-valued? Was it by an independent valuer? Does the company clearly state its policy or does it change from year to year?

Provisions against assets: What sort of provision has been made against assets? Is it enough? What’s the company’s track record of write downs over the years.

As you develop your skills you will begin to intuitively look at different industries and ask the questions specifically related to that area.  Questions we would ask about the assets of a Retailer will be very different to a Mining company.

What’s next?

Don’t worry if you are feeling lost at this point, the aim is to try and build a foundation with each article and bring each component into the valuation equation as we go.

In our next article of this series we will look at another Balance Sheet item – Debt.  This is of particular importance given the recent tightening in the market of available credit and the trouble some companies are having refinancing that debt.

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