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The Search For Value, What Should You Be Looking For?

Most investors, particularly value investors, are interested in finding value in the market. But what exactly is value and where is it coming from? For any investment, there needs to be a process of value creation or realisation for the investment to bear fruits for its shareholders.

There are basically three types of value that an interested investor can look out for.

The Current Earning Power

This is one of the more obvious sources of value for an investors.  Using an example of purchasing a piece of real estate, one can liken the current earning yield of a company to the rental yield that one would receive.

For example, companies with relatively stable earnings year on year such as Starhub Ltd. (SGX: CC3) demonstrates its value creation through its current earnings and positive cash flow. A high dividend payout then passes on the value to investors directly. In such an example, investors might just focus on the company’s current earning power as the main source of value.

The Future Earning Power

Companies need to reinvest its earnings in order to grow. For investors interested in growth, the preferred source of value creation comes from the direct growth of the company’s total value. This means searching for companies with a large growth potential. Such a company might not have much earning power now, but has the potential to earn much more in the future.

Companies such as Global Logistic Properties Ltd (SGX: MC0) might be considered to be a company that focuses on its future earning power. The company needs to aggressively expand its presence in China, Brazil and Japan, which requires large amount of capital expenditure. This leads to a much lower dividend payout for shareholders compared to a company such as Starhub. However, due to the growth potential that the company possesses, some investors are willing to give up the benefit of current earning power, in hope of higher future earning power.

For such companies, the growth potential is where the value lies.

Value of Assets

There are also companies that derive value from the assets it holds. Golden Agri-Resources Ltd (SGX: E5H) has one of the largest oil palm plantation in the world. The huge land bank and plantation is a core source of value for the company.

Valuing a company using its assets is not without problems. A company with a large asset valuation might not necessarily be able to extract value from its assets. In such cases, companies that rely too much on its asset value might end up trading at a very low price to book ratio.

Foolish Summary

As value investors, we put in the extra effort simply to search for the extra value of a company. Value can come in different forms and it is our job as the investors to know what type of value we are searching for when we make our investments.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn't own any shares of companies mention above