Financials Demystified: Long‑Term Assets on the Balance Sheet Explained

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3:06Today, we're going to continue with another episode of Financials Demystified. Woo-hoo. I know you're excited. Today, we're going to talk about some more accounting stuff, and we're going to make it fun and exciting. I promise. Today, we're going to continue our discussion on the balance sheet. And last time, we talked about current assets. This time, we're going to talk about long-term assets, which are all part of total assets. So with that, let's dive in and do a quickie on what are long-term assets. Let's do it. I like to keep things simple, try to keep things relatable to the real world. So for me, when I learned about long-term assets, thinking about somebody's house or office buildings or Target and their stores, Walmart and their stores, Home Depot and their stores, those things helped me conceptualize what a long-term asset is.

4:02And if you think about what it is when we talk about what's a piece of real estate or what's a building, it's something that's going to provide value to the business over multi-year periods. Contrast that to something like a current asset, short-term asset. If I have inventory and I'm Walmart and I'm selling sporting goods, that inventory is an asset that's only giving you that one-time benefit when it is sold and it's converted to cash. these long-term assets are providing cash flow over multi-years. So that's one important distinction. Another is just in the accounting itself. When a company, when a business is investing in the long-term, if they're securing a lease for a building over 30 years, or whatever the lease term is, they are also needing to account for that on the balance sheet in that section.

4:58and the way it links to the cash flow statement is also different. So if you were, again, to use inventory as the counter example, if you are spending or investing as a business to buy some inventory, that would be on the operations side of the cash flow statement. Any long-term assets in particular, I'm thinking of property, plant, and equipment. Maybe we can start with that one. That one seems to be an easier one. But if you're talking about property, plant, and equipment, then that needs to be on an investing section of the cashflow statement. So hopefully I didn't throw too many terms in there, but that's how you need to account for it and think about it.

5:39In your mind, what does it tell you? Like what property plan equipment, are you even looking at it? How does it play a role in looking at investments just in general? Oh, yeah. It plays a huge role. And when you look at the balance sheet, probably the first three things that I look at when I look at the balance sheet is I look at the total current assets, I look at the net property, plant and equipment, and then I look at the total assets. And I do all three of those things in conjunction of how much are each of them as a component of each. So for example, if I'm looking at a company that is, we're going to talk about some of these in a minute, but if I was looking at a company that was maybe more capital intensive, I would expect to see a higher portion of the net property plant and equipment or PPE as a bigger portion of the total assets of the business.

6:42That would logically make sense. Likewise, if the company was more capital light, I would expect to see that as less. And so that can help frame maybe your expectations when you're looking at the business. The other thing is the big reason why I would look at the net PPD or the property plant equipment is because that's a huge investment that the company is making depending on what the business model is. If you're looking at a railroad, they're obviously going to have to plunk down a couple bucks on trains and the rails and the stations and upkeeping all of those things the systems that they use to manage the the trains you know where to where loads are going where they're getting filled where the trains have to go all those things all that stuff has to be managed and that's where that company will spend money on those things.

7:36And you want to see them spend money on those things. If they're not up keeping the rails, they could have accidents. If they're not up keeping the systems, they're not being efficient and they're not delivering loads in a timely manner, which means they're costing themselves money. So you want to see those things growing and that's where you can track a lot of this stuff. All the discussion on the AI CapEx spend, this is where this directly shows up on the company's balance sheets. When you hear all these huge numbers that Meta is throwing out, $600 billion in CapEx spend over the next five years, all those numbers, that's where you're going to start to see that stuff show up is in the balance sheet under net PP &E.

8:22Yeah, perfect. Great example. All these huge data centers are net PP &E. let's start i wanted to start with a example so i talked a few episodes ago about martin marietta materials one of those uh hidden gems that i very much like the business of so if we were to take dave's test i'm pulling up their balance sheet so these are real numbers for 2024 net pp and e is 10 billion and then total assets is 18 billion so 10 out of your 18 are long-term assets. That's a capital-intensive business. What does that tell us? Again, to recap, it tells us that they need a lot of assets. They need a lot of investment in order to grow.

9:11And if that number is growing, then ideally you also see earnings growing, which has been the case for them. Now, like I mentioned a couple episodes ago, if you haven't listened to that episode, I would recommend going back and listening to it. It was our episode about light bulb moments. But what's cool is if you pull up an annual report, you can look in the notes section and they can break down some of these long-term assets and you'll get better sense for every business. Because again, the PP &E for Martin Marietta is going to be different from Walmart. It's going to be different from Meta.

9:47So in the case of Martin Marietta, they have a few that are big line items. So I'll focus on those first. So machinery and equipment. So if you know Martin Marietta, they are aggregates. They are mining the crushed stone and taking that out of the ground, turning it into the aggregates that can become concrete, asphalt, things like that. So six out of the 15, I'm sorry. Yeah. Cause there's some depreciation. So just bear with these numbers, but six out of the 15 is machinery and equipment. So picture, I'm not a construction guy, but like huge kind of crane things that, you know, I can picture this stuff.

10:32If you drive by Aquarius, you can see it. These big machines, you're going to need those, right? Another thing on here is mineral reserves and interests. So when a company like a Martin Marietta goes in and needs to get the government regulations in order to allow them to drill baby drill, that gets accounted for as mineral reserves. And that's another$6 billion. So these big numbers can tell you, okay, I need to learn maybe more about their machinery and equipment, or I need to learn more about what is mineral reserves and interests. And that can be a good way to kind of go down the rabbit hole with some direction of teaching you about what the business is and what's important for the business.

11:19I noticed they doubled that number from 2023 to 2024. So that tells me that they've enhanced their long-term earning power and capacity because that's what the reserves are. Reserves are an estimate of how much of this stuff out of the ground or we can be able to pull up. So that tells me, okay, they are growing pretty aggressively. And then it's up to you then to take the next step. Do I agree with the growth and do I think it's good growth or not? But that's some of the detail that you can find in the footnotes when you're looking at a business that you're familiar with. Yeah, that's a fantastic example.

12:00Can we maybe look at maybe the opposite end of the spectrum and look at a company like NVIDIA. Do you have them pulled up? Maybe you could take a look at their capital expenditures. Yeah, perfect. So NVIDIA, this is for 2024 calendar year. Only 6 out of 111 billion is property and equipment. If you know about NVIDIA, they don't manufacture those great, wonderful chips that everybody loves. They design it on computers and then send it off to TSMC. TSMC manufactures it for them. So actually what's interesting is they just have like a ton of current assets. So they're just like flush with cash. They don't even know what to do with it.

12:53They have$34 billion in marketable securities. They have$8 billion in cash. They have$23 billion in accounts receivable. So they're just really flush with cash. And that's something that is... I don't know. I mean, what does that tell you about NVIDIA other than the fact that they're growing like crazy? To me, it says just capital light and becoming even more capital efficient if they have all this cash and I don't know what to do with it. I'm excited to share our friends over at the Plink app released a major upgrade featuring a sleek new look real-time insights, smoother trades, and tools that help you feel more confident with every move.

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15:43It tells you that, yeah, they are unquestionably capital light. And when you look at their financials, you would expect to see high margins for that business because they're producing such efficient revenues. The cost of goods sold to sell what they sell doesn't cost them that much because they don't have to, to your point, they're not building the chips like TSMC is. and so you would expect to see very high margins and when you look at the margins for that company they are very high and so that's again maybe another way that when you look at the balance sheet it can it should tell you other stories about the company you would expect to see really high margins which you do on the income statement likewise when you look at the cash statement, you would expect to see very high free cashflow generation and lots of efficiency in that area.

16:40And you do. And then it becomes a question of what's Jensen Wong, the CEO, going to do with all that money. And this is where his job becomes critically important. He's done all the great groundwork of setting up the company to be uber successful. And they are. But now the big question is, is what does he do with all that money and what can they do? And I mean, they have lots of choices and whatnot, but kind of going back to the balance sheet, that's how when you do an analysis of the balance sheet, those are the things you want to look for. Like, is this a capital efficient company? Is it a capital light company?

17:18Is there a lot of assets on the balance sheet? What kind of assets are they? And it can tell you a lot about the business. All right. So maybe we could segue to Alphabet? Sure. Yeah, let's look at Alphabet. We'll move on from PP &E for now. I reserve the right to come back to that because it's just so fun for me to talk about that. Let's talk a few other long-term assets. So non-marketable securities and goodwill. I'm going to tackle those two. So just like a company can hold cash, they can also hold bonds. We just did an episode about bonds that's coming out soon. The companies can also hold stocks and they can also have ownership pieces of businesses.

18:11So I liked the example of Amazon actually. I'm going to switch to them real quick. They have non-marketable investments in their footnotes and they said in 2023, they invested in a convertible note from Anthropic. So that's cool. They're lending money to Anthropic, which is a huge AI company, lots of potential, which is convertible. So they might get shares out of that. So high upside for Amazon on a small investment like that for them. Alphabet also has things like that in their footnotes. they also have goodwill. So goodwill is another big way that companies will grow. Some companies will grow through tangible assets and buildings and things like that.

19:03Some will grow by buying other businesses. Berkshire Hathaway, probably the most famous ever company that grew through acquisition. We won't get into the nitty gritty about what goodwill is, but it's basically that's how it's accounted for when you buy a business. You're basically absorbing the other business's assets and then whatever that extra value is, is the goodwill. So what are your thoughts on either of those? I think they are very important to know and understand depending on the type of business that you're talking about. To your point about Amazon, it's very important to understand that they have those equity investments on their balance sheet because that directly impacts their income statement.

19:50And when you look at a company like Amazon, sometimes you will see wild fluctuations in their earnings or their reported earnings. You'll see headlines, earnings for Amazon skyrocket or earnings for Amazon fall off a cliff kind of thing, which are very dramatic. But if you don't understand the connection between a long-term asset that they have bought an equity share in a company on the balance sheet compared to the income statement, then you won't understand maybe why they're seeing such wild swings. swings, I'm sorry. And Amazon in particular, with those equity investments and companies like Anthropic and Rivian, sometimes we'll see these wild swings in their equity, which means that will translate onto their income statement.

20:45And so you may see really high earnings or really low earnings, sometimes based on that, which have nothing to do with the operations of Amazon. And it can throw you off. And so it's an important thing to understand. And it's also important to understand this is how the business is choosing to use their cash flow as a capital expenditure or an allocation strategy. Buying a piece of Rivian for Amazon, for example, could have a bearing on that company going forward. So it could be potentially a really good investment for them because of the trucks that Rivian produces, which could help Amazon in the future.

21:26Same with Anthropic. And same idea applies with Google. Google makes acquisitions and they also make long-term investments. And because they generate so much cash, they have lots of choices of how to divvy that up. Of course, they're reinvesting internally quite a bit, but they also will spend money on things like long-term investments and purchasing other businesses. Many people may not know that Google, some of their most popular businesses, i.e. YouTube, was not something they created out of thin air. They actually purchased the foundation of the business. They, of course, improved upon it, but they bought the foundation and the technology and have improved upon it.

22:10And so that equity investment all those years ago was now benefiting them tremendously. So when you look at something like Goodwill, it is important to understand this is part of how a business will do this. And I was looking quickly through the other companies that Andrew was talking about before we got to Google. When you look at Martin Marietta and NVIDIA, they have very little in Goodwill on their balance sheets because they are not really acquisitive companies. And so that is part of their business model. It doesn't mean they won't do it in the future, but as of today, that's not really been a big part of their business.

22:53It's not the major part of Google, but it is certainly something to keep in mind when you look at the goodwill of the business and when you look at the long-term investments. And for Google, for example, if you add those two up, it accounts for almost a quarter of the, well, maybe not, maybe about 20 % or so of the total assets of the business. So it's not insignificant. So it is something to definitely take into consideration. I found something in the footnotes I thought was kind of interesting. So they recently did a reverse acqui-hire. So we're talking about acquisitions. They did a reverse acqui-hire.

23:33I didn't even know this was a thing, but for last year, they recorded$2.7 billion in goodwill because they did a transaction with Character.ai. Poking around the internet, this website, AIM Media House, talked about how the company basically hired the Character.ai's founders and research team, but then didn't buy the business. But because of the accounting, you still have to treat it as if you had bought the business. It was part of a licensing deal as well. So that's kind of interesting. And then law360.com called it a regulatory gray zone. Reverse acquihires are a regulatory gray zone. So kind of interesting.

24:23That is the world we live in now where you hire people for billions of dollars because they have some AI skill. That's quite extraordinary. It is quite extraordinary. I was relating a story about, I believe it was Meta recently, did something similar where they bought a business for$10-12 billion, something in that range, simply because they wanted to hire the CEO. they didn't i don't think they were particularly interested in the business itself but they wanted they wanted you know the brain power that was running that company as part of meta's ai you know um i guess grand designs and so because they probably couldn't entice the guy to leave that his company they just bought it so yeah now he has no he has no choice but to come work for meta so yeah it's it's interesting you know how you will see some of these things play out over over time one of these days we got to dig into the braves um annual report and just talk about player contracts and things like that that might be fun yeah that would that would be super interesting you know this this this kind of discussion about like buying businesses to to acquire talent.

25:41It reminds me of baseball teams that trade for coaches. I know that's not really an investment thing, but when teams trade for coaches, it just feels different. I mean, because that's kind of what the Cubs did. They traded for Craig Council from the Milwaukee Brewers. And so he left the Brewers and became the coach for the Cubs and they traded for him they they didn't trade players they traded money but it was because he was still under contract that was the only way they could get him to come be the coach for the cubs and it's like and i've seen that happen a few times recently and it just it always strikes me as odd but i i was not meant for this this new era i did not know that's a thing and that's crazy but But yeah, good on them.

26:33I mean, he's a great coach. Yeah. Yeah, for sure. Do we want to touch on maybe how goodwill can impact an income statement? And I'm thinking particularly in write-offs, like how that kind of works and maybe how that impacts a business. Yeah. Unfortunately, I know this topic intimately because it's happened with a business I've owned or a couple. So basically what happens is, again, we're talking about businesses buying other businesses. Not every business deal works out. And so sometimes you overpay for something. And what companies have to do as part of putting their accounting statements together is they are required to assess the different acquisitions they've made, assess the goodwill that's on their balance sheet and decide, okay, is this asset that we thought was going to generate$5 billion in cash flow, whatever the number is, do we now expect it to only generate$2 billion?

27:41So if that's the case, you have to take a write-off of, let's say, $3 billion, whatever the difference is for how much you thought the asset was worth to how much it's worth now. And that comes off as a charge on a company's income statement. It's in this weird kind of thing where sometimes Wall Street hates it. Sometimes they don't care. And sometimes it's like they're happy because it's like we've thrown the kitchen sink at it and we're moving forward. It's like we've gotten rid of all the dead weight on the ship and now financials can be clean. So the way Wall Street reacts is really weird.

28:24But what we care about as investors and long-term investors and part owners of these businesses is this is a clear cut signal that management overpaid on a deal. And so the thing you have to think about is, is this just a mistake? We all make mistakes. Or is it indicative of a management team who doesn't know what they're doing? If it's just a mistake, it happens every once in a while, okay, fine. But if it's something that says, hey, they're doing this a lot or I've lost faith in the way they allocate capital, then maybe it's a red flag to really seriously consider, do I want to still own this stock?

29:11There's all kinds of scales to it, but obviously you want to look at the numbers. And if the numbers are big, you really want to think hard about it. Support comes from WISE, the smart way to manage the currencies you need around the globe. Fed up with losing out to hidden fees when you send money abroad with your everyday bank? Choose the smart way, WISE. You can count on the exchange rate you'd usually find on Google. No unwelcome surprises. Plus, ditch that where's my money feeling. Most transfers arrive in under 20 seconds. Join millions saving billions on hidden fees. Be smart. Get wise. Download the Wise app today.

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30:36And it was, I think it was, I don't remember the exact number, but I want to say it was in the hundreds of billions. And it was a shock to the market at the time because that was just, that was a crazy, crazy thing to see. You know, I haven't necessarily had this happen to a company that I own per se yet. I say yet because it's coming. If you invest long enough, it will happen. And I think one of the things that I try to keep in mind is understand who it was that made the purchase and try not to hold that against. So for example, let's say that CEO A bought the company and made the purchase And then they leave three years into the absorption or the integration of that business.