Below please find the comparison of various asset value approach for better understanding.

In reality, firms are of complex structures, multiple businesses, subsidiaries off on their own, and other features that confuse security analysts, and perhaps the company management as well. Undervalued assets are hidden in these firms, complicated organization have financial statement full of dark corners and secret passageways, terrifying to the novie but potentially rich in treasure for the seasoned explorer. By contrast, simple companies produce financial statements with no place to hide.

Liabilities & Equity are the sources of fund that support the assets. To determine the company value based on the reproduction cost of the assets. Knowing how much money an investor or business person would have to lay out to acquire or replicate those assets is very important. So, value investors need to examine the liabilities side of the balance sheet to see what to spend.

Refer to Greenwald, et al. there are three categories of liabilities:

1. Liabilities that arise intrinsically from the normal conduct of the business. They include a/c payable to suppliers, accrued vacation, other wage costs due to employee, accrued taxes due to government and other accrued expenses. Current liability also belong to this type, which is usually due within a year and bear no interest.These liabilities are easy to be found, we only need to substract the liability book value from the reproduction value of assets to arrive the reproduction value of the net assets.

2. Liabilities that consist of these obligations that arise from past circumstances that are not pertinent to a new entrant. Examples are deferred tax liabilities and liabilities incurred because of adverse legal judgements such as "the company broke the law and owes fines or settlement payments". They are irrelevant for the new comers. The tax law may have changed, or this firm's experience may effectively deter the new people from making the same mistakes. These liabilities will not reduce market value a potential entrant has to make. They are genuine obligations that will have to be paid, they do need to be subtracted from the asset value to see what this firm is worth to investors.

3. Outstanding formal debt of the company. Asset value after being subtracted by the first two liability categories is the asset value which investors have claims. This value will be divided between those who hold the debt and those who own the equity. If we are shareholders or making equity investment, subtract the debt value (Use market debt value, if unavailable use book value of debt) from the remaining asset value. The value of debt should be solid, except in situations of financial distress.

In a highly leveraged firm (e.g. lehman brothers), where debt accounts for a large share of the asset value of the enterprise. A slight error in estimating the asset value will have a major impact on the equity value.

For example A = 100M, D = 80M, E = A - D = 20M

If 10% off, A'=90M [100*(1-0.1)] E'=A'- D = 90M - 80M = 10M

Change in Equity = 100% * (E' - E)/E = -50%

= > Margin of safety (MOS) may be eliminated.

Leverage can be the foe of the MOS, many value investors shy away from company that have high debt level.

Another way to treat the debt is to consider it alongside the equity as part of the market value in the company <- Enterprise Value Approach

Enterprise Value = MV of debt + MV of equity - Cash

If we compare the AV (Asset Value - Sponstaneous & circumstantial Liabilities) with EV (Enterprise Value). And if AV > EV + MOS, then it means good investment opportunity for value investors.

Reference:

Greenwald. B. C. N. & Kiviat. B. (2001). Value Investing: From Graham to Buffett and Beyond. Wiley.

Below please find a video about investing in small cap by Paul D Sonkin. One of the famous value investors at Wall Street and the founder of hummingbird value fund.

Sonkin focuses on micro and nano cap value plays and looks for a discount to intrinsic value. He seeks internal and external catalysts and notes that certainty of outcome and timeline are essential as well.

In his opinion, all value investors are contrarians, but not all contrarians are value investors because value investors look for more information. Value investors not only compare the current price of the securities to its former high, but also to the intrinsic value of the firm (i.e. examine the assets and earning power). Paul D Sonkin was keen to examin broken IPOS, especially when the market condition is favorable. Under favorable market condition, many IPOs will be waiting to debut on the exchange. It is a good opportunities for insider to cash out, for ibankers and brokers to earn money and for managers to raise cash to expand the business at a relatively inexpensive rate. Therefore, the company being taken public will do its utmost to put its best face forward. But usually after being taken public, the IPO price will drop sharply to the value below the intrinsic one. Sonkin would like to do research on these broken IPOs to see if there are any investment opportunities there.

Here is the video about his opinion in small cap.

Reference:

Small Caps Worth A Look. Retrieved from http://www.youtube.com/watch?v=OTM7SEnsbgQ

Top Hedge Fund Managers at Value Investing Congress: Day 1. Retrieved from http://seekingalpha.com/article/203273-top-hedge-fund-managers-at-value-investing-congress-day-1

The reliability of the information and the strategic situation of both firms and industry usually influence the judgment when valuing an asset. Balance sheet is one example for illustrating the influence of the info reliability. Investors need to design how far down the balance sheet they need to go. Benjamin Graham considered only current assets in his valuation. Current assets valuation is accurate based on either liquidation or reproduction cost approach. For the strategic situation part, the investors need to think if the industry is viable. The asset value estimate is based on what they will bring in liquidation. But if they have no market, they can only be sold for scrap. So if the asset value is based on reproduction cost or liquidation approach, the investor need to look for an industry that is either stable or growing.

There are several things worth noting here.

• The more commodity-like the inventory, the less the discount necessary to sell it. While the discount will be higher for highly specialized inventory. If object & technical knowledge is required, please consult the expert appraiser.
• If LIFO is used and item price is soaring, the reproduction cost of the inventory is higher than the published figures.
• PPE is usually the larges non-current assets for most companies.
• If Land market value is lower than the land reproduction cost, the additional cash or the higher market price of the land certainly adds to the asset value of that particular company. This situation is just similar to the companies with a lot of cash to run their business.
• The disparity between the book value and reproduction cost of the plant can be potentially enormous for two reasons:
  1. The depreciation rules by which the company reduces the plant value may bear only the slightest resemblance to what is happening to the asset economic value.
  2. The depreciation we change ourselves to replace this year’s use of the asset economic value is based on historical cost. On other hand, our potential competitors have to pay for the asset in today’s dollars. Their cost should reflect this increase.

The points to note I mentioned above are only some that I found very interesting. The book has also discussed other points such as the goodwill value and the method for assigning a value to the license or franchise. If readers are interested, please feel free to check them out.

Reference:

Greenwald. B. C. N. & Kiviat. B. (2001). Value Investing: From Graham to Buffett and Beyond. Wiley.

如果想計算出Efficient Portfolio, 我們必須能夠運用資產的回報數據先計算出Variance-Covariance Matrix (VCV Matrix)。顧名思義，這Matrix包含了Asset自身的Variance及Asset與其他Asset之間的Covariance。

在數學層面，Variance及Covariance的Formula分別如下圖所示：

Source: http://stattrek.com/matrix-algebra/covariance-matrix.aspx

事實上，在Excel亦有相應的function 可供用家使用的。請留意，Excel提供的Variance和Covariance的Formula是針對整個population size而不是整個sample size的。所以，它們的denominator都是N而不是N-1。若有需要使用sample size的Variance或Covariance，可自行乘以 N/(N-1) 調整。

在可接受的Portfolio Variance的情況下獲取最大的Portfolio Return 或以承擔最少的Portfolio Variance去賺取特定的Portfolio Return 是EF原理中Portfolio Optimization的目標。雖然VCV Matrix的結果會影響其Portfolio的Weighting，它的計算卻未能完美地解釋到Asset Return變化的原因。VCV Matrix在EF的Portfolio Optimization的應用上可能會出現大手的沽空盤或非現實可以完成的買入盤。另外，Asset之間在VCV Matrix的Correlation有時會過大或出現不合理的負數。例如，從1993年到2004年，Boeing與Kellogg的annual price correlation係 -0.1 (詳細計算方法請參考附件)。這顯然是奇怪的。因為Boeing和Kellogg是屬於不同的板塊。因此Boeing股價上升的原因是很難解釋到為什麼Kellogg的股價會下跌。也許可勉強說這是蝴蝶效應吧。但這種關係是不明顯的。

筆者認為VCV Matrix的correlation是可以自行調整的。另外，大手的Large & Short Position亦可以用受到限制的。Financial Modeling的作者Simon Benninga對VCV Matrix的計算主要提出了三個alternatives。筆者不選擇在此詳談因認同作者在後續章節的說法，這三個問題都只能治標不能治本。不過，筆者認為不能因為上述的問題便斷言EF的Portfolio Optimization是沒有參考價值的。筆者建議VCV Matrix中的correlation是可以根據實際的情況自行調整而得出一個比較貼合Asset與Asset之間關係的adjusted correlation。另外，Simon在書中亦指出在Portfolio Optimization方面，Investors是可以accommodate其他的Position Limit，如沽空限制或所有Asset均不得多於百分之二十五的限制等等。

Reference:

Simon. B. (2008). Financial modeling. Cambridge, MA : MIT Press.