The term “hidden values” refers to assets which intrinsic value isn’t reflected on a company’s balance sheet and doesn’t impact the stock price. In other words, the true value of these assets hasn’t been defined yet, thereby giving some investors an opportunity to make money from them. Common examples of hidden values, which can positively influence the stock price growth, are intellectual property, land, and formally depreciated equipment.
Origins of Hidden Values
Sometimes, hidden values appear due to companies' restrictions to follow specific rules of accounting. For example, these rules can require setting a historic cost, or price of purchase, for some types of assets instead of their current market price. In the US there are generally accepted accounting principles (GAAP) which state these rules. Therefore, the difference between a book value and a fair market price of assets is formed. If this difference is significant enough, it might bring profits to investors who identify it.
Also, intangible assets, such as copyrights, patents, and trademarks, have the potential to be the company’s hidden values because they represent its unique intellectual property.
Investment strategy based on the search for hidden values is called value investing. Consequently, investors using this strategy are known as value investors. Hidden values can be detected through a fundamental analysis, which estimates the fair market price of securities by studying relevant macroeconomic (e.g., inflation rate, economic outputs) and microeconomic (e.g., a management style of a certain company, level of competition within an industry) factors. If the book price is lower than the price derived from the analysis, then the shares of the company will potentially generate income in the future.
Examples of Hidden Values
Let’s consider some of the most common examples of hidden values:
- Land – is a type of assets which can grow in price significantly over time. According to the accounting principles accepted in the US, land has to be stated on the company’s balance sheet for the price of its purchase. Therefore, the book and fair values of this asset might be advantageous for value investors.
- Equipment – is another type of assets that can be inaccurately reflected on the balance sheet because of accepted accounting principles. Some equipment units can be depreciated on paper while their actual state of exploitation is much better. Therefore, they can be hidden values as well.