How to Reveal the Hidden Value of Assets
Let’s play a game.
Would you want to invest in this stock in a boring industry that plummeted over 30% from its highs:
Or would you rather invest in this tech stock that climbed over 200% in less than a year and looked primed to climb higher:
Now, you probably already know where this is going to go…
“Obviously,” I hear you say in a nasally voice, “this is a trick, and the stock that looks unattractive will be the better investment.”
And you are correct.
But… why?
You might respond, “Well, I don’t know enough. I’m only looking at the price. I need more information.”
And that, my friend, is going to be the main point of this particular article.
Listen, I’ve been in financial publishing for years now, and I grew up roaming the halls of a brokerage office listening to my dad and grandfather trying to help people grow their wealth.
If it’s one thing I’ve learned over the years…
People do NOT like to buy stocks when they’re cheap…
But they LOVE buying stocks that look like they’re skyrocketing.
The average investor bases the majority of their buying and selling decisions on price alone.
Show someone a stock that’s been climbing, and the fear of missing out kicks in. “I need it I want it,” the limbic, lizard-like nuggets of their brain begin to cry out.
Show someone a stock that’s declined for any reason that has nothing to do with the health and stability of the business… well, you might as well try to sell water to a fish.
The average investor acts like this:
I suspect I know the reason for this.
To most people, the stock market is a rigged casino game they don’t know the rules to.
And the strategies for “winning” the investment game are fairly counterintuitive and tend to run contrary to human nature.
This is why so many people just avoid investing altogether…
(I’ve spoken to TWO people over the last several weeks who have tens of thousands of dollars sitting in an account, doing nothing for them.)
And it’s why so many people investing in stocks (or many other investments) base their decisions on emotions, an irrational black & white/all-or-nothing mentality, gambling logic, and false beliefs.
But investing isn’t (and shouldn’t be treated the same as) a game of craps or pachinko.
When you buy a stock, you’re actually buying a thing.
(Let’s stick with stocks, because that’s one of the easiest investments a person can make with the lowest barrier to entry.)
Specifically, you’re becoming a co-owner of a company, legally entitled to a share of that company’s value.
The CEO and directors of a company have legal and moral responsibilities to shareholders of the company.
The risk of a casino game comes down to randomness and whether or not you’ve broken a mirror within the last seven years.
The risk of a stock investment comes down to a company’s potential and ability to provide value to shareholders...
And information about this potential and ability isn’t always reflected in a stock’s actual market price.
That seems like a simple insight, but it has huge implications for you.
Once you understand these implications, it will change your whole mindset about investing and enable you to invest with less risk and greater certainty and security.
That probably sounds “salesy”... But I don’t care.
I am trying to “sell” you on an idea, a perspective, an entirely different and counterintuitive way of looking at investing (whether it’s in stocks or not) that will be BETTER for you and your wealth in the long run.
To put the idea simply, every stock (and every investable asset traded in a market) has two prices:
A market price…
And an underlying value.
You can only buy and sell shares of a stock at a market’s price.
But you can make your buying and selling decisions based on a stock’s underlying value, which might be very different from the market price.
Anyone who’s ever gone to a thrift store or estate sale and found a Versace bag on sale for $4 understands this concept already.
Anyone upset that a tank of gasoline now costs almost 50% more than it did a year ago understands this concept already.
But failing to understand this…
The difference between the market price of an asset and what an asset is actually worth…
Is one of the reasons why most people fail to make much money in the stock market in the long run.
It’s also why people miss out on big opportunities because they have a warped idea about where big gains in the market come from.
Case in point:
My dad once tried to convince my grandmother to invest in Warren Buffett’s company, Berkshire Hathaway, around 1990.
My grandmother called my dad an idiot.
“There’s no way in hell I’m investing any money in a stock that costs $7,300 per share,” I imagine she said.
Well… even buying just 3 shares of this stock would have made her a millionaire today.
Berkshire Hathaway is practically the gold standard when it comes to well managed businesses that treat shareholders well, and has been that way for decades.
That doesn’t matter, though.
She saw the price.
She didn’t see the value.
And because of that she missed out on a chance to multiply her money more than 55 times over.
Looking at Stocks with X-Ray Glasses
Let’s go back to the stock charts I shared at the beginning…
The first chart is for a company called Cintas (CTAS). This company is in the exciting, red hot, growing industry of… (you ready for this?)... uniforms, floormats, first aid stations, safety products, and soap dispensers.
I’m being snarky, but there’s an element of seriousness, here. Boring businesses are often big businesses.
This company owns 25% of the entire market for uniform rentals… and every year that brings them in over $5.5 billion and growing, not including their other business segments.
Notice, in the chart above, that big positive leap up in 2018?
That coincides with the price chart I showed you, which covered 2017 and 2018 — a period of rapid growth for the company.
Now let me ask you this…
Did it make sense that a company that was now almost 60% more profitable…
Was now also suddenly worth about 30% less?
That’s what I’ve been getting at here…
If you’re just looking at price alone, you’re missing out on crucial information about the health and viability of the business. You might have missed this chance to buy into the company.
And if you were a shareholder in Cintas, you might have been freaking out about the price of your stock investment plummeting.
But if you had a sense of its value?
Cintas’ chart would have looked like this:
The purple line in the chart above is the market price, but the orange line represents the price of Cintas if you factored in its average profits and revenue over time, and what its price normally is relative to its fundamentals.
This chart is basically showing you that shares of Cintas were in the bargain bin, relative to what they were potentially worth.
And had you invested at that moment, when the price looked cheap compared to its value? The price would have nearly tripled and you would have beat the overall market (the S&P 500) handily:
But compare that to the second chart I introduced at the beginning of this article…
That was the chart for the company Zillow Group (Z).
Unlike Cintas, you’ve probably heard of Zillow before. It’s a real estate advertiser, and it’s the leading online platform for researching homes for sale or rent in the United States.
The company wanted to grow by expanding into home transactions as well, capturing a larger share of the $1.9 trillion market that has, since the pandemic, entered a bit of a bubble.
But you didn’t really need to know much about Zillow to understand that the company’s price did not reflect its underlying value or potential in February 2021, when the price spike on this chart occurred:
At that time, Zillow’s price was over two times what its value seemed to be, based on its actual revenues and profits.
And had you invested? You might seen your investment decline by nearly -70%.
Its valuation is one of the reasons why Zillow might have been an unattractive investment at its peak price…
Much in the same way Cintas was attractive during its price dip.
Price is simply what you see.
But if you put on your X-ray specs by looking into a company’s actual financials and results… you can see through to what you actually get when you buy an investment.
(And that’s something you can’t really do at a Blackjack table in a casino…)
Every asset can be priced and valued in some way…
Bond prices and values can be assessed based on yields and par value…
Option and derivatives can be priced and valued based on the same math that describes the movement of particles in a fluid…
Growth stocks can be priced and valued based on their potential ability to capture some percentage of a total addressable market...
Major market indices like the S&P 500 can be valued according to the overall profitability and growth of the economy…
Homes can be priced and valued relative to comparable homes in a neighborhood that sold recently...
Bitcoin can be priced and valued based on the number of active users holding and transacting it.
If you’re looking to purchase or invest in assets...
You will rarely go wrong if you just wait to spot a really good deal on what you want to buy.
That’s all good and well.
But understanding this concept can also help you compound your wealth faster, too.
In the past, I have talked at length about the power of compounding, and how using income to purchase assets that produce additional income can cause your wealth to grow exponentially.
I have also talked about the power of leverage, and the various ways one can use leverage.
Let me show you how it’s possible to use the concept of valuation to accelerate your compounding.
Accelerated Asset Accumulation
You’ve probably heard of dividend reinvestment or DRIP before…
A DRIP lets you buy more shares with the dividend checks income-producing stocks will pay you.
In most investment accounts and brokers, you can simply activate “DRIP” and what this does is tell your broker to automatically take the dividends and reinvest it, buying more of the same stock.
So if you own one share of the $100 stock XYZ, and you have DRIP activated when that stock pays a $1 dividend, you will now own 1.01 shares of XYZ.
This is an effective way to accumulate more shares and compound your wealth.
But as you saw with Cintas and Zillow above…
There’s a good time to buy stocks, and there’s a time you might be better off waiting, or putting that money elsewhere.
This thought allows you to make a simple tweak to your investing strategy, if you’re a long term investor with many dividend-producing stocks or ETFs in your portfolio.
Let’s say, 10 years ago, you were super smart and lucky and happened to have purchased the top 5 dividend producing stocks in the S&P 500 today…
Microsoft, Apple, NVIDIA, JPMorgan, and UnitedHealth.
If you looked at share value alone and didn’t collect any dividends… your portfolio would have grown from $5,000 to $119,044.
Not bad! An investment in the S&P 500 would have only turned your $5,000 into $18,224 (or $22,106 with DRIP).
But let’s say you had DRIP activated for these stocks. This is what your portfolio would have done instead over the last 10 years:
Your $5,000 would have turned into $136,784.
You would have earned three times what you originally invested in dividends alone.
But now let’s make a simple tweak to this portfolio…
We’re going to turn DRIP off…
And every time we’ve amassed at least $100 in dividends…
We’re going to buy shares of the “cheapest” stock in our portfolio, relative to its historical valuation.
Basically, if a stock in our portfolio has gone down in price but maintained its value… we’re going to put all of our dividends in that stock.
What’s the result?
Same stocks, same dividends, same timeframe…
But with this single small tweak…
Factoring a stock’s valuation into where you decide to target your dividend reinvestment…
Your $5,000 would have turned into $170,454.
That’s a $33,000 (~25%) improvement in your portfolio’s DRIP performance…
And a $51,000 (~43%) improvement over your portfolio’s performance without dividends...
Simply by going bargain hunting once every few months.
I originally learned this technique when I was the managing editor of a newsletter and portfolio of stocks at the Palm Beach Research Group, called the Legacy Portfolio.
This technique is called the “Accelerated Accumulation Technique” because, well, it accelerates your accumulation of the stocks in your portfolio.
(Maybe the name could use some workshopping…)
But I’ve backtested this strategy for years, looking at every variable up down and sideways.
It works for any long-term investment portfolio…
And usually between years 3 and 7, a portfolio that employs AAT vastly outperforms a portfolio that just uses DRIP.
You just need three things to make it work…
Buy and hold and don’t sell your stocks (unless something goes catastrophically wrong with one of them)
At least 1 stock in your portfolio that pays dividends
A way to assess the fair value of your stocks.
The Madness of Markets Means Money for You
A market really is just an assembly of people buying and selling something…
And with enough data, transactions, and time, they’ll arrive at some sort of consensus about the price of that something.
This is the “pricing mechanism” of markets, and it’s really cool.
But anyone who’s ever been to a store during a Black Friday sale knows this simple fact:
Markets are full of idiots.
People who do irrational things for irrational reasons.
This is how asset bubbles form…
People buy up tulips and Beanie Babies simply because prices are accelerating upward…
And they never stop and go, “Hey, is this thing worth what I’m paying for it?”
Let’s be real for a moment…
Most people don’t have the time or inclination or desire to look deeply into a stock to try to assess its value.
And that’s fine. This is one reason I think the proliferation of “finfluencers” and newsletters and courses about investing is actually a good thing.
It’s good that people are starting to value economic and financial information, and that more people are investing than ever.
But I see a lot of people buying up assets without any consideration of whether what they’re buying is worth anything.
So the next time you get someone’s advice about what stock to buy…
Or you begin thinking about buying a stock or crypto or house or widget because the price is screaming higher…
Please do me a favor and ask: “Do I feel like I understand what the actual value of this asset is or might be in the future?”
If the answer is “No”...
Maybe you should consider sitting that one out.
There will always be another opportunity to make money.
