Tuesday, November 19, 2013

Value Investing Basics

13350790762026903230 Basics of Value Investing

Basics of Value Investing
By Matthew B Woodruff

When ascertaining a company's value for either purchasing or investing, it is axiomatic that one would look at the company's financial statements. What may not be so inherent, however, is which statements one should look at and what within them is of value. At its most basic level, value investing is when a possible buyer determines the worth of the stock and measures it against it's selling price. If the worth is greater than the price it should be bought. The difficult factor in this calculation is determining the intrinsic value of the company. The basic comparison would be between the company's assets and liabilities. For illustration purposes in this article I will make reference to dollar and share figures used in the 1991 film, "Other People's Money."

When viewing a company's assets there are many different items at which to look. The first and most easily distinguishable would be working capital. Working capital is a great determinant of a company's short-term financial health. Within working capital is cash, the most liquid of a company's assets. The higher a company's working capital the more easily they can finance their future needs. When looking at a company's assets one should look at the salvage value of their property, plant and equipment. The historical value of property, plant and equipment is not as noteworthy as it's salvage value. If an investor, like Danny DeVito's character, Lawrence Garfield, in "Other People's Money", is interested in liquidating their highest concern is the salvage value and not necessarily what the property, plant and equipment bring in through normal operations. Lawrence Garfield references the worth of the company New England Wire and Cable. He states their equipment at salvage value is worth $30 million and their land at fair market value is $10 million. He goes on to talk about subsidiaries of the company that are worth $60 million and they have working capital of $25 million, and 4 million shares outstanding. At these levels the liquidation price of the share is worth $31.25 and it is trading at $14 in the movie, this would be an example of value investing. Even at liquidation this company is worth much more than it's selling for, and therefor a value investment.

In "Other People's Money" Lawrence Garfield also talks briefly about some issues that need to be looked at when investing. Not everything in investing is about looking at assets. If a company has a substantial amount of debt, liabilities or contingencies it can create a lack of clout for the assets they do hold.

If a company is funding their assets by accruing a lot of debt they may not be able to pay back the lenders if their debts are called in the future. This is always something to look at when investing, especially value or liquidation investing. Nearly all companies have a form of post retirement plan whether it be a pension or 401k plan. If a company has a poorly funded post retirement plan it could cause problems in the future for their funding. In "Other People's Money", New England Wire and Cable is "fully funded". This means that they have no need to add any funds at the present time for future retired personnel.

Lastly, according to the generally accepting accounting principles there are certain ways contingencies are booked for a company. In accordance with the principal of conservatism a contingency may or may not be allowed on the financials. If there are lawsuits that have a moderate chance of the corporation losing, it will be booked. If the company has a relative chance of losing them they will at least be footnoted. If the company has a possible lawsuit that would favorably affect their financials, no matter how certain it is, will not be booked, however, only placed in a footnote, until it is won. With this being said it is possible for the company to have liabilities which have not even occurred that would still harm it's intrinsic value.

The paramount issue facing value investing is that there is quite some ambiguity between one investor and another. When looking to value invest there are many ways to determine a company's intrinsic value. The stock price may change, but that is always easily ascertained. The value or worth of the company is left up to the investor to decide, and some calculations and thought need to be taken in to items such as contingencies, subsidiary worth, the type and number of shares outstanding and even post retirement funding.

Article Source: http://EzineArticles.com/?expert=Matthew_B_Woodruff

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