Balance Sheet Factors Assets

I will not go into the details of the balance sheet in this article. A basic knowledge of the area is assumed (if one is looking for a basic knowledge of a companies balance sheet please refer to “The Little Book of Value Investing” by C. Browne (2007) Pages 87-93). However to summarize, a balance sheet is a snapshot within a specific time a list of the assets and liabilities of a company. This list is split into current assert/liabilities and 8long term assets/liabilities.

Net Equity = Assets – Liabilities.

One quantitative indicator which should be measured before investing in a stock is the current ratio. The formula is:-

Current Assets/Current Liabilities

This gives an investor an indication of the cash available to a company to pay of its current debt and obligation. Check out the current ratio over the past couple of years. Has it grown? The higher the number the easier it can pay of its liabilities. Very often investors adjust this formula into what is known as the quick ratio or the acid test ratio which is defined as:-

(Current Assets – Inventory) / Current Liabilities.

This is a more refined metric because inventory is included in the current asset section in the balance sheet and very often inventories are not sold or if they stock pile they are sold at a discount. Investigate if inventories have been rising in the past few years. Investigate if liabilities have been growing in recent years or if liabilities have been growing at a faster rate than assets.

In terms of long term assets, check out if land and stock which has been acquired in recent years has appreciated in value. Very often these entries are placed in the balance sheet at cost price and not mark to market. If these investments have appreciated then the book value of the company will also increase.

Intangible Assets

Intangible assets should be most often taken out of any calculation for the simple reason that companies overpay for them and it is too difficult to place a value on an entry where there is no physical aspect to it. There are two metric tests which we will carry out before investing in a stock. The first one has to do with subtracting goodwill and other intangible assets from the assets section of the balance sheet and calculating the resulting book value from the refined figure namely

Adjusted Book Value = (Total Assets – Goodwill and Other Intangibles) – Total Liabilities

And the resulting price to book ratio is the price per share / adjusted book value per share.

Furthermore as a quick test one can also quickly calculate the intangibles asset ratio:-

Intangibles Asset Ratio = (Goodwill + Other Intangibles)/Total Assets.

According to Heiserman this figure should be less than 20%.