Property, Plant, and Equipment on the Balance Sheet
One of the most useful lines on a balance sheet for business owners and investors is the value of property, plant, and equipment (PP&E). Property, plant, and equipment represents the "fixed assets" of an enterprise. This line item value includes the real estate, warehouse and other structures, presses and other manufacturing equipment, as well as office furniture like desks, file cabinets, and computers. Company vehicles, and other tangible items that allow a company to conduct operations and generating revenue or profit also appear under this heading.
Generally, PP&E items cannot be converted into cash quickly. Rather, the real value lies in its ability to productively serve the enterprise.
PP&E Valuable When Productive, Not When Sold
Think of an incredible business like Colgate-Palmolive (CL), the maker of a wide variety of consumer and healthcare products. It has been operating since Thomas Jefferson was in the White House. It's made a lot of buy-and-hold investors exceedingly rich and had a steadily growing dividend for generations. The products make life better for billions of people, dominating their respective niches. To put it in perspective, as one of the most respected blue-chip stocks in the world, if you had bought $100,000 of shares in the firm 35 years ago, you'd be a millionaire several times over.
At the end of the fiscal year 2017, the Form 10-K showed US$4.072 billion in net property plant and equipment value. If Colgate-Palmolive tried to sell that off in an auction, it would receive only a tiny fraction of that amount. The real source of value doesn't come from the machines. It's not in the equipment. Instead, it's in the company's franchise value. You could have the exact same property, plant, and equipment and you wouldn't be able to do much damage to Colgate-Palmolive because it has centuries of lead time in getting people to trust its products.
You'd need the intellectual property (IP), too. Intellectual property includes items like the brand name, trademarks, and trade secrets.
Low PP&E Relative to Cash Flow and Net Earnings
One of the hallmarks of an excellent business is that it generates high, sustainable returns on capital. That leads to more owner earnings—profits that can be extracted from the business without hurting its competitive position. It also offers built-in protection of purchasing power when inflation comes rearing its ugly head because it takes fewer dollars outlaid to upgrade equipment at the end of its useful life.
Some of the very best businesses you'd want to own don't require any property, plant, and equipment at all. For example, imagine a company that has a contract with a limited liability company. The LLC created an e-commerce solution that solved a lot of the other firm's problems. In exchange, the LLC receives the right to an on-going cut of the revenue generated by this company.
The limited liability company has no property, plant, and equipment. It collects cash throughout the year and they distribute it to themselves, as the equity owners, for use elsewhere. That's far preferable than having to pay for all of the machines, building upgrades, computers and other fixed assets another company would require to make a profit. Economically, the LLC business is superior because they get the joys of ownership without the risks.
When analyzing the balance sheets of companies in a particular sector or industry, be sure to compare the relative property, plant, and equipment of the firms relative to a dollar of after-tax profit generated. If one or more of the businesses are a lot more productive, that can be a sign to look more closely as it could turn out to be a fundamentally superior enterprise.