Hey friends. My book, “Choose Stocks Wisely,” harps on the essential role of the balance sheet in proper risk assessment. Some things are worthy of harping. In my view, the balance sheet is what anchors good investment decisions. It details the nature of the assets you are buying at the time of your decision.

There are methods that value a stock investment based on discounting a future stream of dividends. Of course, the large number of non-dividend paying companies on the market would be deemed worthless by such an approach. Valuing a company based on modeling a future stream of earnings would leave many early-stage biotechnology companies high and dry as they will only burn cash for the foreseeable future. So, not all return-based valuation models universally work. But all companies do have a balance sheet and it exists universally to reveal how much equity there is, the nature of that equity, and thereby to communicate the current financial flexibility of the business with regard to accomplishing a future.

Just as one may shop a Certificate of Deposit for the best interest rate and choose according to the one with the best return potential, it indeed makes perfect sense to choose stock investments with an eye toward return potential. But valuation toward investing should never be exclusively based on the reward potential. There were people forced to seek reimbursement by the FDIC on money invested in CDs when several banks failed in 2008 including the stately Lehman Brothers. And, of course, with stock investments, if the company fails, there’s no FDIC to insure your loss of investment. Just as assessing the balance sheet of a bank holding your CD money is important, how much more important is it to assess money invested into company stock where there’s no guarantee of loss coverage?

The simple truth is I need to know the value of what I’m buying today “as is.” Otherwise, I’m risking losing my money. Only the balance sheet shows me what I’m buying. Higher quality assets are tangible and closer to being converted to cash — like high quality Accounts Receivable, for example. Does the future matter? Certainly! But so does the present. Neither can be ignored. It’s not all about the balance sheet and it’s not all about the return. You see, I don’t want to just buy a right to a future return; No, I want to also buy substance that exists right now. That substance gives me a form of insurance on my invested capital in case the future I’m hoping on fails to happen.

See you next time.