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Don't get fooled by this value trap

Jun 18, 2012

Cash reigns supreme. There is no doubt about it. Especially in times when liquidity is hard to come by and cost of capital is on an increasing trend. Thus, companies with huge cash pile on their balance sheet draw considerable attention amongst investors. And why not? This excess cash virtually belongs to the shareholders. If there isn't any capital expansion plan lined up in the near future this excess cash can be returned to the shareholders. It can be done by either declaring a special dividend or conducting a buy back.

So, going by this logic if a company's stock is trading at price which is lower than its cash per share it becomes a value buy. If not lower, but say for example, even if the cash per share is 60-70% of the stock price the company tends to appear exciting. Now, if this is true then such bargain hunting opportunities should get eliminated as market participants try to exploit the same.

However, there are quite a few companies that are currently trading at a price which is lower than its latest cash per share. So, are these companies value buys? Before we answer that question first let's have a look at these companies. Here is the extract.

Stocks with high cash per share
Company Name Cash (Rs m) Price as on 14th June 2012 No of Shares (m) Cash Per Share Cash per share as % of market price per share
Simplex Projects Ltd. 1,845 50.1 12.6 146.4 293%
Simbhaoli Sugars Ltd. 1,392 23.4 27.6 50.5 216%
Rajesh Exports Ltd. 78,152 130.0 295.3 264.7 204%
Moser Baer India Ltd. 1,831 9.3 168.3 10.9 117%
National Buildings Construction Corpn. Ltd. 11,698 83.9 120.0 97.5 116%
Shree Ganesh Jewellery House Ltd. 6,431 93.2 60.7 106.0 114%
Aqua Logistics Ltd. 2,951 8.7 300.0 9.8 113%
IKF Technologies Ltd. 442 0.9 430.6 1.0 113%
GTL Ltd. 5,488 33.1 148.5 36.9 112%
Deccan Chronicle Holdings Ltd. 7,038 30.3 214.0 32.9 109%
ICSA (India) Ltd. 665 15.0 48.1 13.8 92%
Emco Ltd. 1,554 26.8 65.1 23.9 89%
Bharati Shipyard Ltd. 1,831 67.2 31.7 57.8 86%
Alok Industries Ltd. 11,412 18.2 826.3 13.8 76%
Gayatri Projects Ltd. 1,712 102.0 24.0 71.4 70%
Man Industries (India) Ltd. 3,811 97.5 57.1 66.7 68%
Bharat Electronics Ltd. 65,194 1,243.2 80.0 814.9 66%
Consolidated Construction Consortium Ltd. 1,421 14.0 184.8 7.7 55%
Peninsula Land Ltd. 5,025 34.5 279.2 18.0 52%
Source: Ace Equity. *The cash figures are standalone and are as of the 31 March 2011.

Please note that we have excluded many unfamiliar companies from this list and handpicked a few that are popular. Also, we have excluded banks and NBFCs due to the nature of their business (lending and borrowing cash).

Now, let's turn to our question on buying these stocks. Well, on the face of it these stocks might appear value buys. However, they could well turn out to be value traps. And there are multiple reasons for it. Here's why.

  • First. The cash per share does not take into consideration the level of debt that the company has on its books. A company might have huge cash on its books but at the same time can also have a pile of debt. And since debt holders have the first right of payment before shareholders the net cash (cash less debt) position must be considered. Some examples from our list which have huge amount of cash with high debt include Emco Ltd, Alok Industries and Gayatri Projects. For such companies the high cash per share is immaterial.

  • Second. Although the excess cash belongs to the shareholders management exercises discretion over it. For instance, rather than returning the excess cash management can resort to wasteful expenditures. Taking additional/unwarranted perquisites is one such example. Overpaying for acquisitions is another example where the shareholders money put to use effectively destroys value. Thus, it is the intention of the management that matters the most for cash rich companies. Mr Market recognizes this fact and hence the discount between market price and cash per share for some companies might never narrow.

  • Third. It must be noted that there are many companies that have to give bank guarantees as a part of their day to day operations. And in order to get a bank guarantee the company has to deposit some amount of margin money with the bank. This is particularly true for engineering and construction companies. Thus, in such cases the idle cash that appears on the balance sheet is not effectively idle but is blocked as margin money with the banks. It happens to be a part of the working capital. High cash per share for such companies should garner little attention to value buyers.
Thus, it should be clear by now that buying companies with high cash per share does not necessarily ensure reasonable margin of safety. Vigilant investors should consider various other aspects we just discussed before blindly committing their money to such stocks.

Jinesh Joshi

Jinesh Joshi (Research Analyst) holds a masters degree in Finance and has over 8 years of experience in tracking equities. He has a keen affinity for number-crunching and is often sought after for his valuable insights on financial modeling and valuations. He has a keen eye for spotting emerging growth opportunities across sectors and market caps. Jinesh contributes to our Megatrend investing service The India Letter.


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2 Responses to "Don't get fooled by this value trap"

NIKHIL KHANDELWAL

Jul 1, 2012

GOOD STUDY,Should be read by all investors.Also don't buy MNC,and bigger Cos which also show cash in B/S.
EX-Pfizer,Nestle,Glaxo,RIL etc.So what criteria should be used to Buy CO'S.

Like 

uttam wavge

Jun 30, 2012

ADD one more column to showw LOAN PER SHARE then perhaps the real worth wll b cn

Like (3)
  
Equitymaster requests your view! Post a comment on "Don't get fooled by this value trap". Click here!

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