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Type of Securities Investment Strategies Fundamental Analysis Technical Analysis
Understanding Financial Statements Income Statement Analysis Balance Sheet Analysis Cash Flow Analysis Shareholders' Equity Analysis Ratios and Definitions


Balance Sheet Analysis

 - Leverage and financial
   strength affect share value

 - Liquidity concerns can
   decimate a business

 - Cash is critical, to a point
    * Window Dressing
    * Cash Gap
    * Cash per Share
    * Burn Rate

 - Marketable Securities

 - Receivables are interwoven
    with cash flow
    * Past Dues and Write-offs
    * Receivables turnover ratios
    * Securitizations

 - Inventory - focus on the
   profit margins
   * Perpetual vs. Periodic
      Inventory
   * Inventory Accounting
      Calculation
   * Inventory Costing Methods
   * Lower of Cost of Market
   * Inventory Categories
   * Inventory Turnover Ratios

 - Fixed assets are necessary in
   order to be a world class
   company

 - Liabilities with equity attributes
   are enriching

 - Emphasizing debt net of cash
   can be misleading

 - Book value is a tool to
   properly evaluate a stock

 - Off-balance sheet assets and
   liabilities are legal

 

 


Fixed assets are necessary in order to be a world class company

Fixed assets are the property, plant and equipment of an organization. They are capitalized and, except for “land,” depreciated. Depreciation, moreover, is the process of allocating, to the “P&L,” the cost of fixed assets over their useful life in a rational and systematic manner. Normally, intangible assets are excluded.

Investors need to know if a company’s fixed assets are strategically positioned to manage its current business, as well as its future growth. There has been a big push by companies to become the lowest cost producers in their markets. Multinational companies have contracted out their manufacturing, customer service, and informational technology functions to outsourcing companies in places like China, Poland, India, and South America, where the labor costs are inexpensive. My concern is that once these functions are outsourced, the knowledge is lost forever! An organization cannot be a world-class company, if it can’t produce the products that it sells.

For example, if one owns stock in a company that designs and markets its products, but has no facilities for manufacturing and distribution, it’s just a matter of time before the outsourcing companies wise up and start grabbing more profits for themselves. When a company no longer owns its facilities, its options are limited. Copying and improving upon an existing plant is easy, but building from scratch is difficult. Investors could find themselves buying stock in a company with high profit margins, only to find the margins and value of their shares reduced in the future.  

Investors also need to understand the amount of equity that is invested in fixed assets, in terms of property, plant and equipment (“PP&E”). Most companies do a nice job in describing the location, size, use, and ownership terms, of PP&E in annual SEC 10K filings.

Investors need to focus their attention on the quality of the facilities. Are the plants well maintained, cost efficient and using state of the art equipment, or are they outdated, and cost inefficient? Are the plants ISO certified? Are the facilities updated and conducive to a competitive cost structure? 

Another area of fixed assets that investors should concern themselves with is fair value. The financial statements normally value PP&E at historical cost less accumulated depreciation. Land is usually valued at cost. Market value is always different. Another way of looking at the fair value of PP&E is: what is the maximum collateral value that the banks are willing to lend against.

Assets acquired as part of an acquisition can be written-up to appraised/market value, as long as market value does not exceed cost. Acquisition type companies are always having assets appraised for their acquiring companies. While appraisals are expensive, they do give credence to the reported PP&E values. Investors also need to review undervalued assets on the balance sheet, such as: 

·        Land that was acquired years ago and has now greatly appreciated.

·        Low-cost long-term leases in desirable locations.

·        Fully paid for and depreciated equipment that is well maintained and that has held its value long after its expected useful life.

·        Assets previously written off, that are now in demand.

These situations are more prevalent then one would think. Investors have benefited in the past through increased stock prices or dividends, when the values of these hidden assets were turned into cash flow.  

People make the business, but the facilities also contribute to increased shareholder value.

 

 

 

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