Total assets are a very important component of a company’s balance sheet. Without assets, a stock can’t create earnings, which are fundamental for growing the stock price over the long term.
While the concept of earnings and P/E ratio seems like a relatively easy concept to grasp for most investors, the idea of investigating where those profits come from tends to get lost. The balance sheet and breakdown of total assets is a little bit more involved than a breakdown of a company’s revenue, expenses, and profit—and involves more financial jargon-type terms.
This blog post will fix that today and hopefully give investors, who wish to do fundamental analysis themselves, a broader understanding of exactly what is comprising of a company’s total assets and if these numbers indicate a strong financial position or not.
An asset, in basic terms, is a store of value. That $100 bill is an asset. Your house is an asset. Yes, your car is an (depreciating) asset.
Ok, well we all know that, right? What about the assets of the stock you’re about to buy?
Here’s where it can seem to be more tricky. It might be easy for the average person to count their assets, but seem to be much harder if you want to look at a multi-billion dollar business. Actually, all you have to do is look at their balance sheet. Take Coca Cola, for example.
Out of the list of assets on their balance sheet, here’s the major ones:
–Cash and cash equivalents: obvious
–Equity method investments: money from other businesses they’ve invested in. Yes, businesses can invest in businesses too.
–Property, plant and equipment: Think manufacturing plants, and the land that’s on them. Can be sold for cash in worst case scenario.
–Goodwill: An “intangible” asset. What the business estimates that the Coke brand is worth (i.e. people will buy because it’s Coke not Pepsi).
Their total assets is around $87 billion right now.
So when you buy some Coca Cola stock, you are buying a part of all of these assets. Remember that buying a stock is buying part business ownership.
The question then becomes… is this a lot of assets, or not?
Well pretend you were about to buy the whole business. If you had to pay $800 billion to get these $87 billion in assets, that might be kinda pricey. If you only had to pay $167 billion to get these assets, well that’s a lot cheaper than $800 billion. Right now, the stock is at $43.92, which makes the market capitalization $187.3 billion. So if you buy Coke stock, you pay $187.3 billion for $87B in assets.
That sounds like a bad deal, right? Why only get $87B for $201B when I could just “buy” cash and get $201B for $201B??
Well, the difference is that Coke’s assets produce an income. Those $87B created $6B in earnings last year.
Let’s take this example further.
Ok, to make it simpler: say we have $10,000 to invest/ spend. $10,000 in Coke stock would give us $4,328 in Coke assets and $298 in earnings from Coke.
Say we held the stock for 10 years. That’d be about $2,980 accumulated in earnings [$298 X 10]. If Coke reinvested all of those to buy more assets, we’d have $7,370 [$4,328 + $7,370].
Not great. Especially since we paid $10,000. That means that investors are expecting big growth from Coke to justify that stock price (I haven’t even mentioned liabilities yet).
Compare that to the Dividend Fortress I bought for The Sather Research eLetter in the January 2018 issue (which was issue 39). That Dividend Fortress stock was priced at about $2.8 billion with $2.6 billion of assets and $139 million in earnings.
Using our $10,000 example again:
$10,000 in Jan ’18’s Div Fortress would give us $9,285 of assets and $496 in earnings. Over 10 years, the company would collect $4,960 in earnings, bringing our original $9,285 in assets, assuming reinvestment, to $14,245.
That’s almost double what Coke stock would.
This is a very basic example. Like I said, I’m ignoring liabilities for the moment, and cash, and future growth. But even with a lot of future growth, Coke would have to do exceptionally well or the Dividend Fortress would have to do very poorly for these estimates to line up.
This is what I mean when I talk about the important of valuation. This is where assets become important.
I don’t care if a stock has the most assets in the world, if the price to buy some of these assets is through the roof (the market price), you’re probably not going to have a good investment result.
I’m finding these kinds of deals with assets and earnings every single month—even as the market cruises with a P/E greater than the historical average [as I write this in 2018]. These deals go “undiscovered” because many don’t have that same brand popularity like a Coke brand does.
But they do just as good, in many cases even better, than the popular stocks when it comes to growing and creating profits.
Sometimes these stocks are “business to business” securities, making them relatively unknown to the average consumer. Sometimes these businesses do sell products to the consumer but in a very boring industry or service—making it less obvious that earnings are growing. Yet, it’s often reflected in the growth of total assets and shareholder’s equity.
The best way to find companies with great total assets is to be reading through annual reports of different companies. And that can only be effectively done by learning the skill of decoding the various components of financial statements, like this blog post has done with total assets.
You’ll want to make valuation comparisons with the other financial metrics such as Revenue, Net Earnings, and Cash at the End of Year using the same logic discussed here. Which makes understanding how these assets drive the other metrics so useful. Of the 3 major financial statements, the balance sheet covers this.
The income statement and cash flow statement deal with how a company utilizes their assets to create earnings (profits).
Luckily, I’ve made some simple guides you can follow to decode the income statement and the cash flow statement. Don’t give up on learning, and remember that this becomes a skill that you can use to compound your wealth for the rest of your life.