Assets: The bedrock a company is built upon
Current assets, which I wrote about on Monday, are those that companies can easily draw upon to pay debt, acquire companies, or give dividends to shareholders. On the other hand, the rest of the assets on the balance sheet aren’t so liquid, but they can be even more important.
Property, plant, and equipment
Most often, these items are the materials and factories that the company needs to make whatever it sells. So if, say, GM owned an auto plant that it used to make trucks, it would carry the cost to build the factory on its balance sheet. Over time, as the factory churns out more trucks, the equipment starts to wear out, and so GM will deduct a little bit of value from this asset every year (this process is known as depreciation).
As the factory depreciates, you can start to anticipate when the company will need to lay out a ton of cash (or borrow a ton of money) to buy a new factory.
But unfortunately, for too many companies, new factories have to be built long before the old ones completely wear out, simply because the company needs to keep up with competitors.
Take a company like Coca-Cola, whose formula hasn’t changed much in decades. Although Coca-Cola could make improvements to its factories to find new cost efficiencies, it doesn’t have to. The Coke you drink today is about the same Coke you drank in 1999.
On the other hand, a company like GM, whose inventory needs to constantly change to keep up with other car companies, will need to retool is factories all the time. I’m not an expert on car manufacturing, but I imagine hybrids require equipment that’s a lot different from plain-old gas guzzlers.
So keep those kinds of competitive advantages in mind when assessing the true value of equipment and property.
Goodwill
Goodwill can be confusing for a lot of investors (including me). When one company buys another company, any excess that the purchasing company paid over the target’s book value is considered to be goodwill.
Let’s say Dino’s Burger Hut has $10 million in tangible assets. Joe of Joe’s Shake Shack decides to buy Dino’s Burger Hut for $20 million, because he recognizes that the Burger Hut’s ongoing profitability is worth more than the assets alone. So Joe puts $10 million in goodwill on his balance sheet.
Companies can adjust the goodwill downward if the business that it purchased has depreciated in value for some reason. You can look at increases in goodwill for evidence that a company is making acquisitions. But when adding up how much a company’s assets will protect you when you buy its bond or stock, always remember that unlike other assets, you can’t sell goodwill.
For a lot more great information about goodwill, take a look at this article.
Intangible Assets
Intangible assets are basically all of those things that you can’t physically touch that make a company valuable: Things such as copyrights, patents, trademarks, brand names, and franchise power. When one company buys another, it can carry the value of those assets at their fair value.
Although they used to be able to, companies can’t carry intangible assets on their balance sheet that they developed in-house. So if Coca-Cola came up with a brilliant new drink formula, it couldn’t simply attach a value to that asset on its balance sheet. But if it acquired a company with the formula, it could. Coke also can’t attach a value to its brand (although very valuable) and carry it as an asset.
Long-term investments
Long-term investments, like stocks and bonds, are valued on the balance sheet at the current market price or at cost, whichever is lower. So even if the market price of the asset has gone up considerably, that won’t be reflected in the balance sheet. That kind of improvement won’t be recorded until the company sells the investment.
For some companies (Warren Buffett’s Berkshire Hathaway for example), the value of the investments is often the greatest asset a company has.
Long-Term Assets + Current Assets = Total assets
I’ll write later on the different ways assets can be compared to earnings to measure a company’s efficiency. But that’s enough to absorb for now. If you want further reading before tomorrow, I recommend checking out Warren Buffett and the Interpretation of Financial Statements by Mary Buffett and David Clark. It’s an easy read meant for beginning investors, and I used it myself to double check a lot of this material. Don’t buy it thinking you’ll get some sort of revelation into the way Buffett works. It’s more of an introduction to investing.
On Friday, I’m writing about company liabilities.
— Joe Light
