High return investments often have hidden assets

Hidden value is one of the key factors we look for when we’re picking high return investments to recommend in our investment advisories.

Over the years, many investors have asked why so many of the stocks we recommend have attracted takeover bids. The answer is simple: when we look for stocks to buy, we pay special attention to hidden assets. These are valuable assets that investors overlook, discount or disregard altogether.

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Hidden assets can make a world of difference long-term and lead to high return investments

These same hidden assets have special appeal for companies that are using takeovers to grow. They get more for their money when they buy companies with hidden assets.

The conventions of accounting can keep assets out of view. For example, corporate balance sheets generally show the value of real estate at its purchase price. But many corporations own real estate that they bought decades ago, far below today’s prices. The difference between the current value and the balance sheet value is a hidden asset. But it can quickly become apparent if the company sells the real estate, or makes profitable changes in its use.

Research spending is another source of hidden value. Companies mostly write off research costs immediately, just as they write off everyday expenses such as taxes, wages, utilities and insurance. As a result, research costs tend to depress a company’s profits in the year when the research takes place. This highly conservative approach reflects the fact that research may not turn up anything of value. But successful research builds a company’s body of knowledge. This can lead to new products and faster earnings growth.

Hidden assets can come out of existing brand names that can help launch new products. They can also grow out of government obstacles to the entry of new competitors into a market. They can come out of popular opposition to changes in technology.

Finding hidden assets for high return investments

The best time to find hidden assets is when they’re still hidden, long before the company begins taking steps to profit from them. Understanding and seeking out hidden assets while you’re evaluating a stock can add enormously to your profits in the course of an investing career. But you need the patience to profit from them because they can stay hidden for a long time after you buy.

Hidden assets can also cut your risk. Stocks with hidden assets are likely to hold up better than those whose assets are easier to spot because they are the last stocks that experienced, successful investors sell. When times are good, on the other hand, stocks with hidden assets tend to do better than average. Good times give them opportunities to put their hidden assets to work.

High debt hurts growth

When you’re researching growth stocks, you need to know how much debt they’re holding. Growth companies with a lot of debt have a hard time recovering from an economic downturn.

The more manageable the debt, the better. When bad times hit, debt-heavy companies often go broke first. Especially those that also keep trying to allocate part of their cash flow to paying dividends.

Aim for steady—not outsized—high return investments

You can’t expect to earn an outsize return indefinitely. If you did, you’d wind up with a measurable fraction of all the money in the world, and nobody ever does that.

Regression to the mean is inevitable. No investor and no investment can earn an outsized return indefinitely. Eventually, a high yearly return will come back down toward average.

Focus on investment quality when looking for aggressive stocks with the potential for higher returns.

When we look for aggressive investments, we zero in on companies that have established a business and have at least some history of building revenue and cash flow. We also look for companies that stand to benefit as the economy continues to improve, and have proven management and long-term growth plans.

That’s very different from so-called concept stocks, many of which are start-ups or companies that look to profit from next week’s or next year’s investor fad. These companies can generate big returns in a good year. In the long run, though, they are likely to cost you money.

What characteristics of high return investments do you look for? Share your thoughts with us in the comments.