Value Stock Selection: Starting with Net Assets

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When you select stocks, net assets are often the most intuitive starting point. Many studies have found that companies with low asset growth in the U.S. market can achieve an annual return premium of about 20%. The table below shows the correlation between asset growth and long-term returns:

You can use net assets to initially screen targets, but this metric alone is not enough. You also need to focus on key data such as ROE, profit margins, and dividends to avoid “value traps” in value investing.

Key Points

• Net assets are an important indicator for assessing a company’s financial health. Understanding how net assets are calculated helps you more accurately judge a company’s fundamentals.
• Combining metrics like ROE, profit margins, and dividends allows for a comprehensive analysis of a company’s financial condition. This helps avoid making poor investment decisions based solely on net assets.
• Industry differences significantly impact net asset evaluation standards. Adjust your evaluation methods based on industry characteristics to ensure reasonable comparisons.
• Pay attention to investment opportunities brought by market fluctuations. During market downturns, invest in undervalued high-quality companies to enhance long-term returns.
• Regularly review your investment portfolio and adjust its structure in a timely manner. Monitor changes in company fundamentals to reduce investment risks and enhance return potential.

Net Assets and Value Investing

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Definition of Net Assets

When learning about value investing, you first need to understand the meaning of net assets. Net assets are the result of a company’s total assets minus its total liabilities, reflecting the portion that truly belongs to shareholders. You can calculate it using the following formula:

• Net Asset Value = Total Assets - Total Liabilities

In practice, listed companies typically calculate net assets as follows:

• Determine total assets: You need to identify the fair market value of all company assets, including tangible fixed assets, current assets, and intangible assets.
• Calculate liabilities: Subtract all external liabilities, including short-term and long-term liabilities, from total assets.
• Deduct preferred shareholders’ claims: Before calculating equity value, subtract preferred shareholders’ claims from net assets.
• Divide by outstanding shares: Finally, divide the net result by the total number of outstanding shares to obtain the net asset value per share.

By following these steps, you can more accurately assess a company’s net asset level. This is the first step in value investing and a key basis for determining whether a company’s fundamentals are solid.

Financial Health Assessment

Net assets are more than just a number; they directly reflect a company’s financial health. You can use net assets to understand whether a company has the ability to fulfill its obligations and continue investing. Higher net assets indicate that the company has more assets belonging to shareholders, making it more resilient to risks.

• Net assets represent the difference between total assets and total liabilities, serving as a key indicator of a company’s financial health.
• Net assets reflect the company’s net worth, providing insight into its ability to meet obligations and invest in growth.
• Compared to other balance sheet metrics, net assets offer a clear snapshot of a company’s equity position, while metrics like current liabilities and long-term debt provide context for liquidity and financial stability.

When conducting value investing, you should not only look at the absolute value of net assets but also consider the company’s debt structure and asset quality. Only companies with steadily growing net assets and reasonable debt levels are worth your attention.

Tip: You can combine net assets with metrics like profitability and cash flow to more comprehensively assess a company’s financial health.

Industry Differences

Different industries have significant variations in net asset requirements and structures. When comparing companies, you must consider industry characteristics and avoid applying the same standard to all businesses. The table below outlines the fixed asset ratio characteristics of major industries in the U.S. market:

When engaging in value investing, you should adjust your net asset evaluation standards based on industry characteristics. For example, technology and software companies have a high proportion of intangible assets and a low fixed asset ratio, which does not mean they are inferior. You should compare a company’s net asset structure to the industry average to determine its reasonableness.

By understanding the definition of net assets, financial health assessment methods, and industry differences, you can lay a solid foundation for value investing. This not only helps you identify financially sound companies but also effectively mitigates risks from industry misjudgments.

Principles of Value Investing

Sources of Returns

When engaging in value investing, you need to focus on three core sources of returns: net assets, dividends, and valuation. Each directly impacts your investment returns.

• Net assets provide a minimum guarantee in the event of a company’s liquidation. If you can buy stocks below their net asset value, you are more likely to achieve excess returns in the long term. Many studies have found that companies with net current asset value (NCAV) significantly higher than their market value often deliver substantial annual returns. Through a net-net investment strategy, you can identify companies trading below their liquidation value, meaning that even if the company is liquidated, the remaining assets after settling liabilities still belong to you. Data shows that portfolios holding stocks with net asset value at least five times the company’s current market value can achieve an annual return of 19.37%.
• Dividends are an important way to achieve cash returns. Dividends come from a company’s net income and directly reflect its profitability. Dividend yield is typically seen as a low-risk return method, and holding high-dividend companies long-term helps stabilize your overall returns.
• Valuation reflects the market’s expectations for a company’s future growth and profitability. The lower the valuation at the time of purchase, the greater the potential for future capital appreciation. High valuations often indicate limited future returns, while low valuations may lead to higher returns.

Tip: You can combine net assets, dividends, and valuation to build a multidimensional value investing system, enhancing your investment’s margin of safety.

Valuation Relationships

When analyzing stocks, you must understand the intrinsic relationships between net assets, dividends, and valuation. The table below illustrates their relationships in valuation models:

You will find that the P/B ratio is positively correlated with ROE; the higher the ROE, the higher the valuation the market is willing to assign. Dividend yield, as a key component of total returns, carries lower risk than capital appreciation. Investor psychology also affects valuation, with short-term market price fluctuations largely reflecting sentiment changes, while long-term prices align more closely with a company’s true value. When investing, you should focus on the alignment of valuation with fundamentals to avoid risks associated with high valuations.

Application of Key Metrics

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ROE

When engaging in value investing, ROE (Return on Equity) is one of the most commonly used metrics. ROE helps you assess a company’s ability to generate profits from shareholders’ invested capital. A high ROE indicates that management can effectively use each dollar of shareholder equity to generate more returns. You can break down ROE to further understand its driving factors:

When analyzing ROE, you should not only look at the figure itself but also its sources. If a company’s ROE relies heavily on high financial leverage, the risk is greater. You should prioritize companies with high net profit margins, high asset turnover, and moderate financial leverage. This allows you to effectively identify high-quality companies with long-term growth potential.

Tip: You can combine ROE with net assets to identify companies with sufficient net assets and consistently above-average ROE, as these are more likely to be undervalued by the market.

Profit Margin

Profit margin reflects how much net profit a company retains for every dollar of revenue. When engaging in value investing, the stability of profit margins is crucial. A high profit margin indicates strong pricing power and cost control. You also need to monitor trends in profit margin changes:

• Industries with high profitability face challenges in maintaining profit margins, often due to new competitors entering or innovation-driven disruptions.
• Improvements in profit margins can mainly be attributed to globalization, the shift to a service economy, lower interest costs, and lower tax rates, slightly offset by higher levels of research and development (R&D).

By comparing profit margins within the same industry, you can determine whether a target company has a competitive advantage. Companies with consistently stable or gradually improving profit margins are more likely to maintain performance growth during market fluctuations.

Suggestion: You can combine profit margins and ROE to screen companies with both profitability and efficient asset utilization, further increasing the success rate of value investing.

Dividends

Dividends are a key channel for obtaining cash returns. When analyzing dividends, you should not only look at dividend yield but also consider the sustainability of dividends and the payout ratio. Consistently stable dividends often indicate sufficient cash flow and steady operations. The table below summarizes how dividends enhance the attractiveness of value stocks:

When selecting stocks, you should prioritize companies with a stable dividend history, reasonable payout ratios, and healthy cash flow. While high dividend yields are attractive, if a company’s free cash flow is insufficient, the dividend may not be sustainable.

Note: You can combine dividends with metrics like ROE and profit margins to avoid focusing solely on high dividends while ignoring fundamentals, preventing you from falling into “value traps.”

Case Studies

You can understand how to use key metrics like ROE, profit margins, and dividends to select high-quality companies through real-world cases. The table below shows the performance of several typical investment portfolios in the U.S. market:

When analyzing these cases, you can identify the following commonalities:

• ROE (Return on Equity) shows a company’s efficiency in generating profits from equity.
• Profit margins reveal a company’s operational efficiency.
• Dividend yield needs to be evaluated alongside payout ratios and cash flow to assess its sustainability.
• A company with a 2% ROE may be undervalued for valid reasons, while a company with a 15% ROE that remains cheap is more likely an investment opportunity.
• High dividend yields may attract value investors, but if the payout ratio is too high or free cash flow is insufficient, dividends may soon be cut.

You can draw on these experiences, combining metrics like net assets, ROE, profit margins, and dividends to build your own value investing system. This can effectively avoid “value traps” and enhance long-term investment returns.

Valuation and Dividends

Valuation Fluctuations

When investing, you will find that market valuations are not static. The market trends upward in the long term but often experiences significant short-term fluctuations. These fluctuations provide opportunities. You can invest in undervalued high-quality companies during market panics to enhance long-term returns.

• Market fluctuations offer prepared investors opportunities to buy at low prices.
• Embracing volatility, developing an investment plan, and sticking to it helps you focus on long-term goals.
• Since 1995, the average valuation of the U.S. market has been above historical standards, leading some investors to mistakenly believe valuation levels have permanently shifted upward. You need to be cautious of the risks posed by high valuations and avoid chasing highs blindly.

Suggestion: You can regularly review your investment portfolio, monitor valuation changes, and adjust holdings in a timely manner to reduce the negative impact of volatility on returns.

Role of Dividends

Dividends are an important tool for achieving long-term compound growth. Many investors trust companies that pay dividends more, believing these companies are less likely to engage in accounting fraud.

• Studies show that when trust levels decline, investors are more inclined to choose dividend-paying companies.
• Foundations affected by accounting fraud increase investments in dividend-paying stocks, indicating that dividends enhance investor confidence.
• Dividend reinvestment allows you to use received dividends to purchase more shares, creating a compounding effect. Over time, your shareholding and future dividends increase, accelerating portfolio growth.

By holding and reinvesting dividends long-term, you can accumulate more shares and enjoy wealth growth from compounding. This strategy requires no additional capital but significantly boosts total returns.

Value Investing Process

Process Steps

When engaging in value investing, you can follow these steps:

1. Define investment goals. You need to determine your risk tolerance and expected returns.
2. Screen stocks initially. You can select financially healthy companies based on metrics like net assets, ROE, profit margins, and dividends.
3. Conduct industry analysis. You should assess whether a company’s net asset structure is reasonable in the context of its industry’s overall trends.
4. Evaluate management and operational efficiency. You can review the company’s annual report to understand the management team’s capabilities and operational conditions.
5. Allocate assets. You need to compare your portfolio’s maximum potential loss with the market’s assumed maximum loss, diversify investments appropriately, and reduce concentration risk.
6. Review periodically. You can check your portfolio quarterly or annually and adjust holdings in a timely manner.

Risk Mitigation

You will encounter various risks during the investment process. Below are common risks and mitigation strategies:

• Liquidity Risk: You should monitor a stock’s trading volume to avoid buying assets that are difficult to liquidate.
• Concentration Risk: You can diversify investments to avoid holding too few stocks.
• Market Risk: You should understand overall market fluctuations and set reasonable stop-loss points.
• Business Risk: You can analyze a company’s operational condition and select those with strong profitability.
• Political Risk: You should monitor policy changes impacting companies, especially in cross-border investments.
• Currency Risk: You can monitor USD exchange rate fluctuations to assess risks in foreign currency assets.

Practical Suggestions

When screening value stocks, you can follow these suggestions to avoid common pitfalls:

• Analyze debt-to-equity ratios to avoid highly leveraged companies.
• Focus on the relationship between assets and liabilities, selecting companies with high-quality assets.
• Understand industry trends to avoid investing in highly competitive or heavily regulated industries.
• Monitor management integrity and operational efficiency, being cautious of overly optimistic companies.
• Check sales growth and profitability over the past 12 months, selecting consistently profitable companies.
• Avoid investing in stocks that have reduced or canceled dividends.
• Diversify investments, prioritizing value stock mutual funds or index funds to reduce individual stock risk.

You can use the above process and suggestions to build your own value investing system, effectively enhancing investment safety and long-term returns.

When engaging in value investing, you should start with net assets while combining metrics like ROE, profit margins, and dividends to comprehensively evaluate company quality. Academic research indicates:

• Traditional book value fails to reflect the true value of intangible assets.
• Incorporating intangible assets leads to better portfolio performance, enabling better identification of high-quality companies.

You need to focus on valuation levels, avoiding a focus solely on low prices or high net assets. Continuous learning and practice will help you build your own investment system.

FAQ

Is higher net assets always better in value investing?

You cannot judge solely by the level of net assets. You also need to combine metrics like ROE, profit margins, and dividends. A company with high net assets but poor profitability may not be worth investing in.

How can you determine if a company’s dividends are sustainable?

You can review the company’s dividend history over the past five years. You also need to monitor free cash flow and payout ratios. Companies with consistent dividends and sufficient cash flow are more reliable.

Why should you focus on industry differences?

You need to consider industry characteristics when selecting stocks. Different industries have varying net asset structures and profit models. You should compare with industry averages to avoid misjudgments.

Do companies with low ROE have investment value?

You can focus on companies with low ROE but steadily growing net assets. If a company is in a transition period or at the bottom of an industry cycle, with potential for future improvement, it may be worth considering.

How can you reduce risk when investing in value stocks?

You can diversify investments by selecting multiple companies. You should also regularly review your portfolio, monitor changes in company fundamentals, and adjust holdings in a timely manner.

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