Fundamental Analysis Overview
Let me explain fundamental analysis to you directly: it's a method I use to forecast a stock’s potential trajectory by examining its financial statements, competitive position, and economic factors.
What Are Hidden Values?
Hidden values are assets that are undervalued on a company's balance sheet and therefore may not be incorporated into or reflected in the company's share price.
As a value investor, I seek to uncover these hidden values on a company's balance sheet that are often overlooked by the average investor, typically through fundamental analysis. Consider an asset marked at book value but actually worth more in terms of its fair market price—that's a hidden value.
Key Takeaways
- Hidden values are balance sheet items whose true market value may not be reflected in a company's current share price.
- Assets like land or equipment depreciated to book value are examples of potential hidden values.
- Value investors are keen to identify companies with a cache of hidden values, hoping that its full value will be realized in due course as reflected in its stock price.
Understanding Hidden Value
The essence of value investing, as I see it, is buying undervalued securities—that is, undervalued relative to their intrinsic values. I'll determine a fair value in any number of ways, depending on the type of company, and then compare this intrinsic value to the value accorded to the security by the market. If the discount is attractive enough, I'll buy the shares and patiently await the potential convergence of the current market value to the intrinsic value.
An asset that a company assigns a certain value on the balance sheet to conform to generally accepted accounting principles (GAAP) may be worth more in terms of fair market value. Intangible assets such as trademarks and patents could contain hidden values, as could reserves of natural resource companies. In some cases, if an asset has long been held at a cost-basis on the books, it could be worth substantially more than what is reflected on the balance sheet. Likewise, if an asset has been depreciated for accounting purposes, especially when using an accelerated depreciation schedule, it may actually hold more market value than it is attributed to have on the firm's balance sheet.
Example of Hidden Value
A classic example of a hidden value is land. According to GAAP accounting rules, land must be held at historic cost, but there's a high likelihood that this kind of asset has significantly appreciated in value if owned for a long period of time. If you isolate the land from the balance sheet and value it at current market prices, it would probably have a value greater than what is recorded in the financial statements and perhaps comprise a non-insignificant portion of the company's market capitalization.
Take a retailer such as Tiffany or Macy's, with prime property in Manhattan, for instance—they could possess this type of hidden value. As a value investor, I would separately calculate the current market value of their properties in determining whether or how much of a discount to intrinsic value exists.
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