Value investors, who value investments based on the replacement value approach, typically assign a low value to property, plant and equipment and other non-current assets on the balance sheet.
I will like to focus on specific non-current assets and their valuation drivers in this article.
Plant and equipment are core operating assets used in the production of goods and/or provision of services. Companies have to constantly reinvest in their plant and equipment to maintain the equivalent returns on the same existing assets – this is reflected in depreciation expense in the income statement and maintenance capital expenditures in the cash flow statement.
Estimating the true useful lives of plant and equipment is as much an art as it is a science and consequently depreciation may understate the true reduction in economic value of the plant and equipment each year. A deeper look at the depreciation policy of plant & equipment and knowledge of the rate of technological obsolescence in the relevant industry gives better insight to the true carrying values of plant & equipment on the balance sheet.
Investments in Associates & Joint Ventures could represent either extreme undervaluation or extreme overvaluation cases. If associates and joint ventures are private companies, they are typically valued at cost, significantly undervaluing the value of such companies. On the other hand, if associates and joint ventures are publicly listed, their valuations are typically mark-to-market and could be overvalued in the event of a euphoric bull market or vice-versa. In the event that sufficient information is available, investors will be well-advised to do their own independent valuations of these associates and joint ventures.
There could be value hidden in non-operating assets on the balance sheet. The most common case is that the company has significant real estate on the balance sheet in the form of investment property. The real estate could be leased out for rental income or sitting idle on the balance sheet, a subsequent sale of the property or conversion to more high value usage could unlock the value of the real estate and bring a windfall along with it. Bill Ackman from Pershing Square and Martin Whitman from Third Avenue have been known to target such companies for investment.
I will like to focus on specific non-current assets and their valuation drivers in this article.
Plant and equipment are core operating assets used in the production of goods and/or provision of services. Companies have to constantly reinvest in their plant and equipment to maintain the equivalent returns on the same existing assets – this is reflected in depreciation expense in the income statement and maintenance capital expenditures in the cash flow statement.
Estimating the true useful lives of plant and equipment is as much an art as it is a science and consequently depreciation may understate the true reduction in economic value of the plant and equipment each year. A deeper look at the depreciation policy of plant & equipment and knowledge of the rate of technological obsolescence in the relevant industry gives better insight to the true carrying values of plant & equipment on the balance sheet.
Investments in Associates & Joint Ventures could represent either extreme undervaluation or extreme overvaluation cases. If associates and joint ventures are private companies, they are typically valued at cost, significantly undervaluing the value of such companies. On the other hand, if associates and joint ventures are publicly listed, their valuations are typically mark-to-market and could be overvalued in the event of a euphoric bull market or vice-versa. In the event that sufficient information is available, investors will be well-advised to do their own independent valuations of these associates and joint ventures.
There could be value hidden in non-operating assets on the balance sheet. The most common case is that the company has significant real estate on the balance sheet in the form of investment property. The real estate could be leased out for rental income or sitting idle on the balance sheet, a subsequent sale of the property or conversion to more high value usage could unlock the value of the real estate and bring a windfall along with it. Bill Ackman from Pershing Square and Martin Whitman from Third Avenue have been known to target such companies for investment.
