Rick Konrad

You have asked an excellent fundamental question, how should we value a stock? Let's look at each of the approaches you have raised.

Book value is merely an accounting value. It reflects the difference between asset value (based on historical costs) less the debts and other prior liabilities. So, if the historical asset value based on the original cost does not reflect the current value, it can be a very misleading statistic. For example, many integrated steel companies had very high cost assets based on their historical valuation, yet were no longer economic and produced little cash flow or earnings. Companies like this traded at a discount to their book value, but were not really bargain investments. One other accounting wrinkle that I should mention. When companies are buying back a lot of stock at prices that exceed their book value, these actions actually reduce the book value. Consequently, there are many companies that have had active share repurchase programs where the book value can even be negative. Yet, many of these companies continue to grow revenues, cash flows, dividends, and earnings. There are other companies which may have understated values, for example, raw land that has appreciated over time, but is still reflected "on the books" for its original cost. So, book value is not a reliable determinant of valuation.

Enterprise value takes into account the stock market's assessment of the value ( the stock market price) plus the debt of the company less any cash holdings of the business. It's as if you were buying the entire business, paying off all the shareholders, as well as the debt holders, but you would finance part of this transaction with the company's own cash holdings.The cash is subtracted because it would reduce the cost of buying the entire business. Sometimes, one can find stocks with negative enterprise value, that is, the cash on the balance sheet exceeds the valuation of the rest of the business. This can be helpful in finding bargains.

The discounted cash flow method is one of the most commonly used approaches by professional analysts and investors. As others have described, it does determine the value of a business by taking a present value of all future cash flows from the business and adjusts these for the liabilities. However, there is "art" in using this tool. One must be able to make reasonable assumptions about the future profitability of the business and obviously that can change with competition and obsolescence. One must make assumptions about what sort of discount rate to use. That discount rate reflects not only the "cost of money," or the cost of financing, but your desired rate of return. In other words, how much return would you expect from this sort of a business. If a business has a highly predictable cash flow, you probably would demand a lower return. On the other hand, if the cash flows were somewhat unpredictable, or competition in the industry was rampant, you would want a higher rate of return, so your discount rate should be higher.

Most advisors do not attempt to value individual securities, but prefer to utilize professional active investors through Separately Managed Accounts or mutual funds or alternatively, use passive investing approaches. Proper security analysis requires education that goes beyond the scope of Series 7 holders or even CFP certificants. Individual investors should be mindful of the risks associated with security selection and inadequate diversification.

The discounted cash flow approach is the best tool that we have to determine "intrinsic value," but it does rely on assumptions which may be unrealistic and discount rates which depend on an assessment of the riskiness of the cash flow.

I would not dismiss REITs as a wealth creation tool. In fact, REITs have three huge advantages over direct ownership of property:

1. Diversification- I certainly can't afford to own a 500 unit apartment building or a large shopping mall, but I can participate in the ownership through a REIT.
2. Liquidity- I can sell a publicly traded REIT just like I can sell any other stock, but the frictional trading costs are much lower.
3. Professional management- I don't have to deal with tenants, property managers, etc.

I agree with other comments about non-traded REITs. In my opinion, they can be a roach motel...easy to get in, but you can't get out. Beyond the illiquidity issue, the valuations of trading property from other elements of the real estate operator's business to your unlisted REIT are not always independently determined. This creates a huge potential conflict of interest.

Greater volatility is a bit of a nonsensical argument when you deal with publicly traded instruments versus something that is non-public. Every publicly traded security is subject to the behavioral whims of buyers or sellers, as Buffett and Benjamin Graham illustrated it, much like having a bipolar partner. But owning a piece of property is also subject to local markets. Same proposition here, if someone offers you a price you don't like, you don't accept it. The same principle applies to a publicly traded REIT.

The returns for publicly traded REITs over the long term have been the best of any asset class. That's not to say that they are always the best, your return depends on the price that you pay...no different than buying any other property or stock.

For perspective, let's look at the NAREIT index of Equity REITs (all of these are public) versus the S&P 500. Yes one can argue that this data is subject to survivorship bias, but the same is true for the S&P 500. Many of the companies in the S&P 500 are no longer around and have been replaced by new entrants. Data goes back to 1971 and goes to end of 2015 and is total return (capital appreciation plus dividends).

Let's look at a more current period, say starting in 2000

Now, one can argue that the comparison is unflattering because of high valuations for stocks in the Internet era of sock puppets and other tom-foolery that existed at the beginning of 2000. But the data demonstrates quite effectively, in my opinion, that REITs (publicly traded REITs) have provided great wealth creation opportunities.

Of course, there were some terrible years along the way just as in the stock market. They coincided with periods of interest rate concern as well as naturally falling real estate prices. For example, total returns in 2008 were down 41% for the NAREIT index. But as you suggest in your question, income for equity REITs has grown as properties have appreciated, as mortgage debt has been managed, and as rents have grown.

What characteristics should the individual investor look for in an equity (as opposed to a mortgage REIT- a whole different animal)?

There are many qualities to look for. Let's start with the real estate portfolio characteristics:

1. What is the type of property? Commercial, multi-family, and numerous varieties after that!
2. What is the occupancy of this property?
3. What are the lease spreads like?- the difference between lease revenues and mortgage interest expenses
4. What is the geographic spread of the REIT? Focused on particular states, regions or national in scope?
5. How diversified is the tenant base? Too much concentration with a particular "shaky" tenant?
6. How do lease expires look over the next few years? A lease expiry is an opportunity to renegotiate rents for both landlord and tenant.

Like any other security you would want to know the leverage, how much debt there is, and what the interest coverage is. Many REITs have publicly traded debt and preferred securities that have credit ratings which provide some "comfort" as to their quality.

Finally, you need to have some sort of valuation metric to appraise the REIT. The most common is Price/ FFO (see https://www.investopedia.com/articles/04/112204.asp)

Of course, an investment advisor or planner who is well versed in this sector can help construct a REIT portfolio that meets these criteria.

Another important aspect to REITs is that they must pay out a substantial part of their income in order to maintain their tax-free status as an entity. This also means that distributions received (akin to dividends) are fully taxed unless they are held in a tax-deferred vehicle such as an IRA or 401(k).

Hope this addresses your question. Good luck in your investments!

No, such a share repurchase would not appear in the daily "listed" volume reported by the stock exchange. Most share repurchases take place as "Open market purchases" which are governed by something called Rule 10b-18. Hence, there are limitations for companies to buy at the open and within the last half hour before the close. As well, volume cannot exceed 25% of average daily trading volume. Private transactions do not follow these limitations.

But in a private transaction, the share volume is not evident in the exchange's volume. But disclosure of share repurchases, either on the exchange or in a private transaction, must be reported in its next periodic report (10-Q or 10-K) of the total number of shares repurchased, the average price paid per share, the number of shares purchased as part of a publicly announced program, and the remainder to be purchased.

Private repurchases of stock are reported eventually through the Q or the K, but not in the trading volume.

Hope that helps!

A wrap account is a brokerage account for which the client pays a management fee rather than pay commissions for individual transactions. The original premise behind fee-based management versus transaction-based management is sound. The incentive for the broker changes from activity to growing assets or client wealth and should align the interests of the broker with those of the client. This avoids accusations of "churning," a practice of excessive trading which some unethical brokers have used to generate commissions, not necessarily with the clients' best interests in mind.

However, the charging of a management fee implies active management of the account rather than merely monitoring of the account. So, there is a temptation for some brokers to convert large inactive accounts to fee accounts, in order to replace the lack of commission activity with fee income. This should not result in zero turnover of your holdings. For example, in a bond portfolio, there are often opportunities to replace more expensive bonds with higher quality or cheaper alternative bonds. Ditto for an equity portfolio. But often does not imply daily or weekly change for the sake of change.

Be alert to what you are being charged. For example, some wrap accounts which consist largely of mutual funds, charge a management fee for "wrapping" the portfolio as well as the underlying management fees of the mutual fund. How much asset allocation expertise is really being employed here?

We have also seen mutual fund wrap accounts operated by a large mutual fund sponsor in which the mutual funds were reallocated every two weeks. In broadly diversified mutual fund portfolios, that seems like too much allocation activity, at least, to us.

In short, investors should take time to discuss with their broker or advisor how the wrap account will be operated and what the objectives and goals are in order to ensure that your own interests and objectives are being met.