An asset is a valuable resource that someone owns with the expectation that it will provide some future benefit. For investors analyzing companies, assets are long-term "things" like intellectual property, buildings, and technology. In other words, assets are used by companies to generate cash flow, reduce costs, or grow sales, and thus, ultimately, to increase a firm's value.
On the balance sheet, a firm's total assets are equal to the sum of total liabilities and shareholder's equity.
How can I use information about assets when I invest in stocks?
The value of assets themselves is not enough to determine a stock's quality or valuation. Assets have to be used in conjunction with other fundamentals:
- For example, you can compare assets with the company's earnings using the return on asset ratio, which indicates how profitable a company's assets are at generating revenue. You can also compare the company's current assets with its current liabilities using the current ratio to determine how effective a firm is in meeting its short-term obligation. You can even compare the company's total assets with its total liabilities using the debt ratio to determine how leveraged the company is. A higher return on asset, current ratio and the lower debt ratio are indications of high-quality stock, which is generally more attractive to investors. This could explain the K-shaped recovery that we are currently facing, as an increase in demand for quality stocks has caused their price to increase (the "flight to quality" phenomenon).
- You can also determine the stock's valuation using the company's assets by subtracting the company's liabilities and dividing this number by the total number of shares. The value you will get is called the company's book value per share. If the book value per share is higher than the stock price, the stock is considered to be undervalued. The opposite is also true: if the book value per share is lower than the stock price, an investor can argue that the stock is overpriced. This is an approach commonly used in "value investing".
- However, some assets sometimes do not show up on the balance sheet. For example, if Tesla's book value per share is $6.98 and its stock price is $424.68, the company might not necessarily be overvalued as the excess value might have come from a loyal customer base. Conversely, if BNP Paribas' book value per share is now $85.96 and its stock price is $30.23, it does not mean that its stocks are undervalued. The market may recognize that BNP Paribas could be an older company with limited growth potential. A better alternative valuation method would be the dividend discount model, the discounted cash flow model, or price multiples model, which provides a more updated and dynamic view of the company's stock valuation.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies