One of the most useful lines on a balance sheet for business owners and investors is the value of property, plant, and equipment, known in short as PP&E. As a whole, property, plant, and equipment represents the "fixed assets" of an enterprise. This line item value includes real estate, warehouses, and other structures; presses and other manufacturing equipment; as well as office furniture such as desks, file cabinets, and computers. Vehicles and other tangible items that allow a company to conduct operations and generate revenue also appear under this heading.
- The real value of PP&E is influenced by a brand's trademarks, name recognition, and other intellectual assets.
- A business that generates high returns on capital has more profits and can more easily upgrade equipment at the end of its useful life.
- Businesses that perform online or intangible services may not require many or any PP&E assets to make a profit.
- Investors can compare the value and use of PP&E between companies in the same industry to find good investments.
PP&E Valuable When Productive, Not When Sold
The overall value of a company will dictate the value of its PP&E. Think of a business like Colgate-Palmolive, 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: Colgate-Palmolive is one of the most respected blue-chip stocks in the world. If you had bought $100,000 worth of shares in the firm 35 years ago, you'd be a millionaire several times over.
At the end of the fiscal year 2018 the company showed $3.881 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 buildings. Instead, it's in the company's franchise value.
Generally, PP&E items cannot be converted into cash quickly. Rather, the real value lies in their ability to serve the enterprise's productivity. A smart investor knows how to spot that 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, too, including items such as the brand name, trademarks, and trade secrets. These may not be listed as part of PP&E on a balance sheet, but they certainly influence the total value of that line item.
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 to upgrade equipment at the end of its useful life.
Some of the 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 firms' problems. In exchange, the LLC receives the right to an ongoing cut of the revenue generated by this company.
The limited liability company has no PP&E. It collects cash throughout the year, which the owners can then distribute to themselves for use elsewhere. That's far more 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. The LLC business is a superior investment because its owners get the joys of ownership without the risks.
PP&E and Your Investment
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 to a dollar of after-tax profit generated. If one of the businesses is a lot more productive, that can be a sign to look more closely. Chances are, it is a fundamentally superior enterprise for investing because its PP&E is generating much more profit for its owners.