Wednesday, February 9, 2011

Hidden Assets

We've focused a lot on hidden liabilities on this blog, because they are important. Company liabilities that don't show up on the balance sheet (such as operating leases and outstanding stock options) must be accounted for, or investors could be way off in their estimations of a company's value. But sometimes, companies have tangible hidden assets as well.

For example, consider Lorex Technology (LOX), a provider of security camera solutions. In its last quarter, the company earned $2.7 million on a market cap of just $10 million. But it's important to realize that much of those earnings were not sustainable; the company only earned operating income of $1.8 million. A large part of the earnings, therefore, came from the realization of an asset that wasn't even on the balance sheet: tax losses from previous years.

This is a tricky one, because sometimes companies do include future tax benefits as assets, and sometimes they don't. It comes down to how likely management thinks gains will be realized to offset the losses. But even if a conservatively-inclined management doesn't include the tax assets on the balance sheet (by taking a valuation allowance against them), they will still be written about in the notes to the financial statements. Armed with the knowledge of the company's tax losses, investors can then make their own decisions about how realizable those tax benefits are, and thus incorporate these assets into their company valuations.

In most cases, these valuation allowances against tax assets won't amount to much. But in other cases, they can be a large and determining factor, particularly as many companies emerge from a recession where they saw large losses. Therefore, it's important for investors to know to look for such accounts when formulating their valuations.

Disclosure: None


Anonymous said...

it is the same as thinking a company will pay in the future a dividend

Anonymous said...

even if you strip it out and just take the $1.8mm on the $10mm mkt cap, its still ridiculously cheap. i notice its more than doubled since that point and still appears cheap.