Investing in the stock market doesn’t have to be a random game of chance. Sure, you could pick your stocks by throwing darts at relevant pages in the Wall Street Journal, but if you’re serious about investing to earn long-term gains, that obviously isn’t the approach you’ll want to take.
Whether it’s on a stock exchange, via a private equity venture opportunity or even just as a partner business, If you’re considering investing in a tech company, you want to assess that company’s value. This is easier said than done, since it encompasses far more than the company’s documented liquidity and net worth – you’ll also need to understand whether the stakeholders in the business are capable of maximizing the value they can potentially derive from the assets they have available, to massively grow their profits in the future.
It isn’t a simple matter to make these determinations, because there are many variables that can affect the outcome. It’s especially tricky in the case of early-stage tech startups, where establishing product-market fit, exploring growth levers, and optimizing the product experience are considered paramount. Monetization generally comes later. In fact, one recent analysis of all tech companies going public found that only a quarter of them were profitable.
However, with some effort spent on research, you can get an idea of whether a particular company is headed towards prosperity or financial doom.
For starters, a company’s balance sheet can give you a head start on understanding what that business’s reported total net worth is. If you want to see a detailed example of how to arrive at this understanding, take a look at this explanation of balance sheet analysis. Here you can see full breakdowns into the company’s shareholder equity, which is calculated according to assets versus liabilities, both virtual and realized.
In general, there are several things you can learn by looking at a tech company’s balance sheet.
The Company’s Assets
A tech company’s tangible assets could include cash, real estate, vehicles, equipment, machinery, inventory, accounts receivable and other valuables. The balance sheet should include a list of all valuable tangible items owned by the company.
Tech companies frequently also have intangible assets. Intangible assets are valuable assets that do not possess a tangible, physical form. Sometimes these can be challenging to value and quantify. Examples of intangible assets are a company’s brand name, market share, and customer list. Copyrights, trademarks, patents and other intellectual property items are also counted as intangible assets.
It is not unusual for tech companies to have massive amounts of money tied up in patents and other intellectual property. According to Forbes, intellectual property can account for up to 90 percent of a typical S&P 500 company’s current market value.
When you review a tech company’s balance sheet, you need to be aware that intangible assets will not always routinely be included. This is one tricky thing that tech investors must take into account when attempting to understand a particular company’s value.
Accountants are likely to record an intangible asset on the company’s balance sheet if the business buys or acquires it. However, that’s only typical in cases where the asset has an identifiable value and could be expected to have a long-term value. Otherwise, the books are unlikely to include these intangible assets.
Therefore, when you do your due diligence on possible future tech company investments, you’ll want to look into the extent that the companies you’re considering have made sizable investments in intellectual property that are not specifically recorded in the asset list on their balance sheet.
The Company’s Liabilities
A company’s liabilities – its debts and other financial obligations – are also recorded on its balance sheet. These could include loans payable, payroll obligations, deferred tax liabilities and any other outstanding business expenses that will need to be paid in the future.
In most cases, investors can focus primarily on assets to determine a tech company’s potential for long-term gains. However, there are also many cases in which the company’s liabilities paint a picture of volatile liquidity, so it’s important to drill down into the details here as well. This is where performing an ad hoc scenario analysis can come in handy.
Publicly traded companies have shareholders that invest money into the company. These investment dollars, along with the company’s retained earnings, are reflected on a company’s balance sheet under the label of “shareholder’s equity.”
The value of the company’s assets should be equal to the value of the company’s liabilities plus its shareholders’ equity.
What These Balance Sheet Entries Can Reveal to You
- You can determine whether a company is solvent or insolvent by examining its balance sheet.
- You can use the information on the balance sheet to gain an understanding of how well a company is taking advantage of its assets and transforming them into profits.
- You can use this information in conjunction with other information to make an estimation of whether a particular company is likely to be a viable investment or not. For example, you can compare one company’s balance sheet against its competitors’ balance sheets.
These are some of the most important things you can learn by looking at a tech company’s balance sheet. Alongside P&L and cash flow statements, the balance sheet is one of the most critical documents to examine when you decide whether or not it would be wise to invest in a particular company. However, true due diligence requires looking beyond publicly available documents.