Applying Buffett’s return on net tangible assets method to MS International, Haynes and Dewhurst

Yesterday’s Newsletter taught us that we need to use a measure of net profits as a percentage of net tangible assets to judge many value investments.

We also know that any observations of past returns on tangible assets are useful only in so far as they convey information about the future. To connect the future with the past we need a large dose of judgement based on qualitative reasoning.

There were a few other elements to pick up, e.g.

• Add back the year’s amortisation of accounting goodwill to the profit number because this does not reduce economic profit;
• Deduct tax from profit because we are interested in after tax return;
• Accounts receivables to be included in the tangible assets figure because this is a use of shareholders’ money;
• In evaluating managers’ efficiency in applying shareholders money to investment then what they paid for an acquisition, including all the accounting goodwill already deducted, should be included (added back);
• Conservatively estimate earnings power (a much bigger concept than reported profit);
• Estimate an adequate level of tangible assets to generate earnings power.

Unfortunately Buffett does not express the elements we are to take from the balance sheet to arrive at a suitable Net Tangible Assets, NTA.

But, now that we have a starting point for our thinking we can get to grips with the reality of modern company accounts.  We’ll learn by confronting each issue as we go.

The raw data – with a few twists

I set out in a common form the data presented in the annual accounts of our three companies and work from there (most recent year).  Balance sheet numbers are for the start of the year.

£’000s	MS International (April 2017)		Haynes (May 2017)		Dewhurst (September 2016)
INCOME STATEMENT
Profit after tax	1,498		1,374		3,508
Amortisation charge this year for accounting goodwill following acquisitions	0		0		0
Exceptional items distorting profits (positive or negative)	0		50		0
Profit for shareholders	1,498		1,424		3,508
CURRENT ASSETS AND LIABILITIES
Inventories	7,043		4,614		4,751
Receivables	8,996		7,499		8,056
Cash needed for operations (assumed)	1,000		1,000		1,000
Other current assets	902		926		0
Payables	-15,253		-5,188		-4,502
Short-term debt	-0		-2,163		0
Other current liabilities	-154		0		-348
Working capital for operations	2,534		6,688		8,957
Surplus cash (assumed)	11,758		1,548		13,958
NON-CURRENT ASSETS AND LIABILITIES
Property, Plant and Equipment	15,955		8,434		8,581
Goodwill in BS	2,700		2,883		2,695
Previously written-off acquired goodwill – add back	0		0		6,328
Other acquired intangible assets in BS	0		3,683		83
Previously written-off other acquired intangibles – add back	0		3,411		657
Long-term debt	-0		0		0
Other non-current liabilities	-0		0		0
Net non-current assets for operations	18,655		18,411		18,344
OTHER ITEMS TO CONSIDER
Defined benefit pension deficit	7,644		15,101		12,197
Internally generated intangible assets capitalised to BS	2,971		15,815		88
Investments (in shares, bonds, etc.)	0		0		0
Operating lease non-cancellable commitments	1,138		572		480
Preference share capital	0		0		0
Minority interests in profit	0		0		55
Minority interests in net assets	0		0		534

There are a few things to think about with MS International

1. Which NTA?

The net tangible asset amount used by the managers during the year might change considerably over the 365 days. In such circumstances, if we use the opening NTA in the denominator we’ll get a very different percentage return on NTA than if we use the closing NTA figure.

A possibility here is to use the average of the opening and closing NTA.

Keeping things simple for today, I use what the managers had at their disposal at the beginning of the year.    In future I’ll use the average between the two balance sheets.

2. “Tangible” here has a special definition.

Tangible here includes the intangible asset of goodwill created from buying another company – for MSI £2,700k.

However, in the same way as conventional NTA calculations, it excludes internally generated intangible items (For MSI £2,971k).

MSI has many items included as internally generated intangible assets in its BS:

Trade names £755k;

Design database £559k;………….

………………To read the rest of this article, and more like it, subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1

CLICK HERE TO REGISTER FOR FREE ON ADVFN, the world's leading stocks and shares information website, provides the private investor with all the latest high-tech trading tools and includes live price data streaming, stock quotes and the option to access 'Level 2' data on all of the world's key exchanges (LSE, NYSE, NASDAQ, Euronext etc).

This area of the ADVFN.com site is for independent financial commentary. These blogs are provided by independent authors via a common carrier platform and do not represent the opinions of ADVFN Plc. ADVFN Plc does not monitor, approve, endorse or exert editorial control over these articles and does not therefore accept responsibility for or make any warranties in connection with or recommend that you or any third party rely on such information. The information available at ADVFN.com is for your general information and use and is not intended to address your particular requirements. In particular, the information does not constitute any form of advice or recommendation by ADVFN.COM and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Authors may or may not have positions in stocks that they are discussing but it should be considered very likely that their opinions are aligned with their trading and that they hold positions in companies, forex, commodities and other instruments they discuss.

WHAT IS ADVFN?

ADVFN covers all things stock market.

From the news and opinion pieces on pages like this to share discussion forums, charting tools, financials, live share prices and Level 2, order book data

If you trade or invest ADVFN has the tools you need to make the right decisions.

• 

  101 Ways to Pick Stock Market Winners

  You need the number one bestselling investment guide, the definitive text for day traders, investors and stock pickers.

• 

  The Death of Wealth

  Dissecting the global economy and the financial markets, the book lays out the evidence for the next economic game changer: the Death of Wealth.

• 

  Justin Waite

• 

  Lending Works

• 

  Ed Liston

• 

  Faraday Research