Three Types Of Value That Can Be Found In The Market: Part One
After investing in the stock market for more than a decade and having interviewed many great investors around Asia, I realised that most of the value that we can find in the stock market can be grouped into three main segments. They are:
1. Asset Value
2. Current Earnings Value
3. Growth Value
Firstly, let’s take a look at how we can find companies with “Asset Value” in the market.
It’s All About The Assets
As the name suggests, companies with asset value possess most of its potential within its assets. This means that we are looking for companies with valuable assets in its balance sheet but are not recognised by the market.
For example, a property company might own many properties on its balance sheet. It might have a net asset value of S$2 billion if all its properties are revalued at market price. Yet, it might only be valued at S$1 billion based on its share price. This means that this company possesses “Asset Value” for the investor.
A typical method of valuing such companies is using the price to book ratio (P/B). The assumption is that investors have to take it that they are expecting the full asset value of these companies to be realised by the market in the future.
This method might be useful to value companies with liquid assets such as banks or insurance companies. It might also be used to value companies with assets that are easily valued, such as properties.
The Disadvantages
However, investors have to be careful when using this method. This is because the hidden value of some companies might never be realised. This could be due to poor management or structural decline of the business, among other issues. Such companies are called “value traps”, where they might appear cheap to an investor, but their value is not able to be unlocked easily.
Foolish Summary
Most value that can be found in the market can be segmented into three main groups – asset value, current earnings value and growth value. Asset value can be found in companies whose share prices are trading below what their assets are worth in the market. Investors can profit by investing in these companies, effectively buying the assets of the companies at a discount. However, there are some risks involved in this method as investors might be unknowingly buying into a value trap.
