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How to Detect Fake Cash - Avoid Net Cash Stocks with These Warning Signs

November 03, 2012 | About:
It is common for classical value investors to buy stocks trading less than net cash as a bargain or low-priced stocks with strong balance sheet positions in terms of a net cash position. This is generally true, but what if the cash is fake?

Watch out for the following warning signs:

- Cash-rich with extremely low deposit rates.

If the company’s cash yield is significantly lower than bank deposit rates and government bond yields, it could indicate a possibility of fraud or embezzlement.

- Cash-rich with low dividend payout or no dividends

If the company has huge amounts of excess cash not needed for operating or investing needs, it should return the cash to shareholders. It is a sign that the cash is not there.

- Cash-rich with high leverage

If a company has large amounts of cash at hand, it should reduce financial distress risk and interest expense burden by repaying the debt. The cash on the books could be non-existent.

- Cash-rich and doing more fund raising

Companies which frequently raise capital or borrow are at the mercy of capital markets. It is likely that a Ponzi scheme could be at work, with companies seeking fresh capital to fund “fake cash.”

- Cash-rich with long cash conversion cycle

Cash conversion cycle (inventory days plus receivable days minus payable days) is more than 90 days.

The cash cycle is a reflection of how long it takes a company to get paid for its cash outlay in running the business. If a company has sufficient cash, it should not be paying trade creditors late or having trouble collecting cash from trade debtors.

In closing

As usual, caveat emptor. When it is too good to be true, check again to be sure.

About the author:

Mark Lin
Mark is a private value investor and runs the Cheapskate Investing website which borrows from the wisdom of value investing giants, using a systematic quantitative screening approach to filter the global stock markets for cheap deep-value cigar-butts and wide-moat compounders. He publishes value investing case studies, investment checklists, and potential stock ideas on the Cheapskate Investing blog. He is also a regular contributor to various value investing communities.

Visit Mark Lin's Website

Rating: 3.7/5 (23 votes)


Dr. Paul Price
Dr. Paul Price premium member - 2 years ago

BRK would violate your rules.
Marklin - 2 years ago

Hi Paul, thanks for your comments. These warning signs are meant to be a second-level check for investors who rush into buying such net cash stocks without proper due diligence. Successful investing is all about minimizing blow-ups such as fake net cash stocks. But I agree that blindly following investing rules and checklists can lead to false positives and missed opportunities.

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