Answering this question is kind of like answering your kids when they ask where babies come from. Most people think that the market performs some kind of magic, taking competition, innovation, and resources and shaking them together, laying the results out under the sunshine of disclosure, and slowly, gradually, value emerges.
But it doesn’t work that way.
Skilled managers run a business for profit. They look minimize their costs, try to hire talented staff, and look for ways to expand without betting the ranch. Sometimes they pick up undervalued assets along the way—real estate or other businesses that have more potential than they’re selling for. Because accounting counts what it can measure, these assets stay on the balance sheet at cost, and can become precious gems hidden in a financial statement filled with slag.
Finding hidden assets—and avoiding financial icebergs that can sink an otherwise sound enterprise—is my main goal in dissecting a company’s annual report. Study is important. If you buy stocks without doing research, you’ll have the same success investing as you do in a poker game if you bet without looking at your cards.
Financial value isn’t magic. It’s something managers build over time. Financial quality can help a company weather rough economic seas without running onto the shoals. And it can keep your portfolio afloat.
Douglas R. Tengdin, CFA
Chief Investment Officer