[SSLance]

Net Asset Value…How do we as investors put an actual value on the companies we own, want to own, or want to sell?

I just went through the exercise of updating a financial statement for my partner and something interesting came up. A couple of his business interests are 2 real estate partnerships he bought into in the mid 80s. Of the 9 partnerships he was in at the time, only 2 of them survived. One is a shopping center and the other is a mobile home park.

The shopping center has finally turned the corner and just recently finished paying it’s loan off and the mobile home park is still struggling, but hasn't had a cash call in many years now.

The question came up of how to value the ownership stake in each of these business partnerships on his financial statement. Do you use the cost basis, what the latest partnership balance sheet shows for owner equity, or a multiple of the earnings the partnership pays out each quarter?

Think of the shares of stock each of you have bought in certain companies in the same way. Basically you are in partnerships with the other owners of the company. You have a cost basis in the shares, the stock price dictates the asset value (market value) of the company, and the dividend that is paid out is the income from the company.

The accountant in me wanted to use the balance sheet number, add up the assets, subtract out the liabilities and divide what was left by ownership shares and use that number.

The cost basis really only comes into play after the asset has been sold, used to figure out the tax liability on the sale. It is not typically representative of the net asset value. It is used to figure the total ROI though.

The earnings multiple seemed to be the logical answer. Have any of you ever looked at PE ratios and multiples when trying to put a value on a company you own? Somewhere between 5 and 10 times earnings is considered the “standard” when valuing a privately held company (PE ratios are typically MUCH higher on publicly traded companies). So you take the dividend\distribution said partnership is paying, multiply it by 10, divide by ownership shares and boom, there’s your net asset value…right?

That is what my partner’s financial adviser wanted to use in this instance for the shopping center. It was a justifiable value that looked pretty good on paper too. The thing is, the mobile home park in the scenario above…pays a tiny dividend\distribution. When asked how to put a value on it, the FA said to leave it like it was…using the balance sheet method like I always had in the past. That was a justifiable value just as well, and looked much better on paper than the earnings multiple. The FA has no stake in these assets, he is just helping with the overall picture. The financial statement is prepared to give to the banks that hold notes held by my partner as part of the reporting process. My point is, one can use numbers and how they are arranged to make just about any point they want to on paper.

In reality, what your ownership in this company is really worth…is what someone else is willing to pay for it. In a publicly traded company, the market determines that value. In a privately held company…the only way to tell for sure is to put it up for sale.

In the case of the shopping center mentioned above, the balance sheet shows asset values of close to 8 million dollars. They were paying a dividend\distribution of $800,000 a year before the loan was paid off, now they should be able to pay a dividend\distribution of 1.7 million a year. Ten times earnings would put the company valued at 17 million dollars, right?

Here’s the kicker though. Is the property pumping out great income right now? Sure…after 30 some years of losses, then partial income, then finally getting on the right track and producing…sure it’s paying out good income. Problem is…what do you do with the asset now? If you were to sell the company, the assets are almost completely depreciated…that means the first thing you have to do is recapture all of that depreciation…at regular income tax rates. Then everything above that after your initial cost basis is deducted…is subject to capital gains income tax as well. Not too mention that all of the dividends\distributions that you have been collecting over the past few years have also been taxed as regular income… If one wants to really figure the total ROI over the years accurately, the cost of divesting the asset HAS to be figured into the equation.

So “just don’t sell it” is the answer. Okay, you leave it in the account\trust it is sitting in and you pass away. Anyone check to see what Estate Tax rates are these days? Before that asset gets transferred to your heirs, if the estate is of any size at all, good old Uncle Sam is going to take a fairly significant portion of it. And in most cases, the asset is going to have to be sold at whatever market value is at the time…to raise cash to pay the estate taxes.

My reason for bringing this up in this thread is that it is my belief that one must pay attention to the net asset value of any investment they own. Anything that can affect that value beyond the owners control must be paid attention to by the owner. And there are a lot of things that can affect that net asset value that are beyond the owner’s control.

The 1986 Real Estate tax law changed the way commercial real estate property was depreciated and set that whole industry on it’s ear and affected not only the whole economy, but directly the savings and loan industry and the owners of commercial property across the country. In 2008, the failure of the bond insurance companies (AIG, Lehman, etc) due to involvement in bad CDOs and the resulting meltdown took down the net asset values of everyone’s stock portfolio.

Say one of the good companies you own, good dividend paying company…has trouble making money for a long period for some reason out of their control. See the 2008 recession… Say they have to cut their dividend rate because of cash flow deficits. First thing that happens is their net asset value drops as there are more sellers of the stock than there are buyers. Don’t think for a second that ANY company out there won’t pay attention to their share price dropping and resort to practices that are not in their normal realm to try to prop their share prices back up again. Sometimes these practices work other times they only make things worse (See JCP for one example). You as a shareholder are in the meantime…just along for the ride. You have a choice to make, continue to hold the company even with the reduced dividend rate and hope it comes back, or sell it at a loss and try again with another company. Neither are very good options…and both directly affect the total ROI figure negatively.

Another factor is the “the stock is only worth what someone else is willing to pay for it” scenario. If the large institutional investors decide for whatever reason that the company you own doesn't fit in their portfolio for whatever reason, they can drive the price of a stock down just by flooding the market with sell orders. If there aren't enough other buyers out there to buy up those shares, the law of supply and demand kicks in and the share price goes down. So, what do you do…hold it and hope it turns around? Or sell and cut your losses and try again somewhere else.

I firmly believe that the large institutional investors can drive a market one direction or the other strictly to build opportunities in for them to make more money on the back side. Retail investors are just along for the ride. Don't get me wrong here, this works both ways. I've been on the upside of these deals as well. Sometimes you just catch a wave and ride it...nothing much more fun than when it's going your way. But on paper, neither way makes much sense or is justifiable.