Many value investors describe what they do as buying something for less than it is worth. One example of this would be paying less for a share of a company than it has cash in the bank (also per share). An even better deal would be paying less than a company would have cash in the bank after it paid off its debt. Then, an investor will truly get money for nothing.
Here is an easy formula to help with the determination: Market Capital + Debt – Cash. If the result is negative, an investor is getting more than he or she paid.
So how does one find these companies? Conveniently enough,
Market Capiral + Debt – Cash = Enterprise Value.
A company with a negative enterprise value meets the “free money” criteria. One can use stock screeners to find companies with negative enterprise value, such as the NY Times screener.
But what about the business of a company? True, investors in a company with a negative enterprise value get that company's business free. However, if that business is losing money, the “free” cash may eventually get used up.
Let's say a company is not losing money. How does an investor get paid from this scenario? Some investors may like it if a company pays out its excess cash via dividends. However, with the coming increase in dividend taxes, this may not be advantageous outside of a tax-advantaged account. Another way for an investor to get paid is to wait for price appreciation and sell. When to sell? A reasonable target may be when enterprise value reaches zero, but depending on what a company's business does, that target may change.
One may say, it's a nice idea, but does it work? Well, Old School Value did a back test on negative enterprise value stocks. Per those results, a portfolio comprised of such stocks would have produced market-crushing returns.
To summarize: Negative enterprise value stocks give you some free money and a free business. They may, as a group, outperform the market. Watch out for companies that lose money and get paid via dividends or price appreciation, depending on taxes and other considerations.
(Editor: GuruFocus' Graham NCAV Screener screens for similar stocks)
Here is an easy formula to help with the determination: Market Capital + Debt – Cash. If the result is negative, an investor is getting more than he or she paid.
So how does one find these companies? Conveniently enough,
Market Capiral + Debt – Cash = Enterprise Value.
A company with a negative enterprise value meets the “free money” criteria. One can use stock screeners to find companies with negative enterprise value, such as the NY Times screener.
But what about the business of a company? True, investors in a company with a negative enterprise value get that company's business free. However, if that business is losing money, the “free” cash may eventually get used up.
Let's say a company is not losing money. How does an investor get paid from this scenario? Some investors may like it if a company pays out its excess cash via dividends. However, with the coming increase in dividend taxes, this may not be advantageous outside of a tax-advantaged account. Another way for an investor to get paid is to wait for price appreciation and sell. When to sell? A reasonable target may be when enterprise value reaches zero, but depending on what a company's business does, that target may change.
One may say, it's a nice idea, but does it work? Well, Old School Value did a back test on negative enterprise value stocks. Per those results, a portfolio comprised of such stocks would have produced market-crushing returns.
To summarize: Negative enterprise value stocks give you some free money and a free business. They may, as a group, outperform the market. Watch out for companies that lose money and get paid via dividends or price appreciation, depending on taxes and other considerations.
(Editor: GuruFocus' Graham NCAV Screener screens for similar stocks)
