A Negative Enterprise Value Screen: Bargain Stocks Trading Below Net Cash

Monday, Jan 30 2012 by
A Negative Enterprise Value Screen Bargain Stocks Trading Below Net Cash

In Brief

A Negative Enterprise Value screen is a bargain investing strategy which looks for companies whose cash is worth more than the total value of their shares and long-term debt. The idea is that these stocks represent a theoretical arbitrage opportunity whereby a suitable motivated acquirer (e.g. a Private Equity fund) could buy all of the debt and equity in a firm and use the cash to cover costs and keep the difference. Most likely to be relevant at times of market stress, it is a variant of the Net-Net strategy espoused by Benjamin Graham, albeit it focuses on cash, rather than other receivables. 

What is Enterprise Value? 

Many investors focus on market cap -  i.e. share price * number of shares - as a measure of the market valuation of a company (this is the figure that is used in P/E calculations for example). This figure is widely available but, in reality, it is not the best measure of a firm's valuation, as it ignores the impact of the capital structure of the company. It would treat a highly leveraged company in the same way as a debt-free company, despite the fact that the equity holders in the first scenario sit behind the (potentially substantial) claims of the debt-holders in the event of a liquidation. 

A better measure is Enterprise Value (available for all stocks as part of Stockopedia Premium). This is defined by summing a company's market cap AND its long-term debt / preferred shares minus its cash (together known as "net debt" or "net cash" if cash exceeds debt). To illustrate the calculation, if a company has a market cap of £100 million, £50 million in outstanding debt, and £25 million in cash, its enterprise value would be £125 million (£100 million + £50 million - £25 million). The reason this is a more complete valuation is that is that, if somebody bought all of that company's outstanding shares at the market price, that person would also take on all its obligations and cash. 

In our negative Enterprise Value screen, we look for those (rare & unusual) companies that have a market cap less their net cash balance. In effect, this means that a shareholder is buying into the cash at a discount and receiving a claim to the rest of the company for free. The idea is that, in…

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