Assets held by companies that are not accurately reflected on their balance sheet
Hidden values are assets held by companies that are not accurately reflected on their balance sheet. As the valuable assets are hidden, they are also not reflected in the company’s current stock price. Many types of assets can be considered hidden values, such as real estate, natural resources, or customer loyalty.
Since hidden values do not appear on the balance sheet, it results in a company taking on an actual value that is greater than what appears on paper. Investors that uncover hidden values can achieve capital gains, as hidden values eventually expand profits, attract new investors, and push up the stock price.
As the name implies, hidden values can be difficult to find, as they are often understated or missing from a company’s balance sheet. As such assets are obscured, they are not simply found by analyzing financial statements or using analysis programs. To uncover hidden values, an investor must spend substantial time and effort into researching and fully understanding all aspects of a corporation.
One of the reasons assets are hidden is accounting standards that influence how companies report their assets. One such example is real estate – according to Generally Accepted Accounting Principles (GAAP), companies must list their real estate assets at historical cost, which is the original monetary value of the asset when it was first acquired.
For assets like real estate, their value rises substantially over time, yet the increase is not captured on the company’s balance sheet. Also, many other assets may be overlooked when analyzing a company’s financials. They can include reserves of natural resources, brand equities, and investments that are off the balance sheet.
To find hidden values, investors must conduct sufficient due diligence to establish a company’s inherent market value and then compare it to the current public market value. For publicly-traded companies, the inherent market value can be compared with a company’s market capitalization. If the inherent value appears to be higher than the market value, there exists the potential for future gains, as the market currently undervalues the company.
By investing in an undervalued company, the shares are essentially trading at a discount, and therefore value can be captured. If the hidden assets can expand profits, the company will attract new investors, and eventually, the stock price would increase. Investors who bought in early would see capital gains as the company rises to fair market value.
To reap the benefits of hidden values, it’s important to find them early before the rest of the market. Timing is crucial, as the hidden values must be found before a company begins to profit off them. Investing in undervalued companies early on can add tremendous value to a portfolio. Still, it’s important to be aware that the assets can remain hidden for many years before increasing profits.
Investors can reduce their risk exposure by investing in undervalued companies, as they are typically the last stocks that experienced investors sell. When the economy is on an upward trend, companies with hidden values tend to do well, as they can access more opportunities to put their assets to work.
Real estate assets are among the most common types of hidden values, as they are often are under-reported on the balance sheet. When a company acquires real estate assets, the purchase price is listed on the balance sheet. Yet, over time, the market value of that asset can rise significantly beyond its historical value.
At times, a company’s real estate assets can exceed its entire market cap. For example, a department store with declining sales may suffer losses. Still, if it owns the properties on which it operates, it may be able to repurpose the property into residential towers or office buildings, generating greater value.
For companies that operate in commodities such as gold, they may hold exclusive rights to mines with the potential for future profits. Although the mines possess inherent value, their full earning potential may not be fully accounted for in a company’s balance sheet.
With significant investment levels, the resources within the sites can be fully realized, which would increase profits and attract more investors.
Companies with a strong base of loyal customers often own an undervalued asset, which is customer loyalty. If a customer engages in consistently positive interactions with a company, they develop a level of trust that makes them more receptive to new products.
It opens the possibility for future growth, as new offerings would see a better reception from a base of loyal customers. As consumer loyalty takes years to develop, a company with a strong base of long-term customers build an asset that isn’t accurately reflected on the balance sheet.
CFI is the official provider of the global Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:
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