Jun 18, 2012|
Don't get fooled by this value trap
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.
Stocks with high cash per share
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.
Source: Ace Equity. *The cash figures are standalone and are as of the 31 March 2011.
||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.
|Simbhaoli Sugars Ltd.
|Rajesh Exports Ltd.
|Moser Baer India Ltd.
|National Buildings Construction Corpn. Ltd.
|Shree Ganesh Jewellery House Ltd.
|Aqua Logistics Ltd.
|IKF Technologies Ltd.
|Deccan Chronicle Holdings Ltd.
|ICSA (India) Ltd.
|Bharati Shipyard Ltd.
|Alok Industries Ltd.
|Gayatri Projects Ltd.
|Man Industries (India) Ltd.
|Bharat Electronics Ltd.
|Consolidated Construction Consortium Ltd.
|Peninsula Land Ltd.
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.
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.
- 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.
||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.
More Views on News
Jun 10, 2017
Forty Indian investing gurus, as worthy of imitation as the legendary Peter Lynch, can help you get rich in the stock market.
Aug 22, 2017
It's surprising Warren Buffett hasn't warned investors about the expensive stock market? Let us know why.
Aug 22, 2017
Post demonetisation, a cut in bank savings deposits rates was in the offing.
Aug 22, 2017
Today, we are attacked by one preposterous thing after another, each of them even more absurd than the last.
Aug 21, 2017
Most Indians who cannot find jobs, look at becoming self-employed.
More Views on News
Aug 17, 2017
A small-cap Indian company with high-return potential and blue-chip-like stability is set to supplant the Chinese players in this niche segment.
Aug 10, 2017
Bill connects the dots...between money and growth, real money and real resources, gold and cryptocurrencies...and between gold, cryptocurrencies, and time.
Aug 12, 2017
The India VIX is up 36% in the last week. Fear has gone up but is still low by historical standards.
Aug 10, 2017
Bitcoin hits an all-time high, is there more upside left?
Aug 16, 2017
Ensure your financial Independence, and pledge to start the journey towards financial freedom today!
Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement. LEGAL DISCLAIMER:
Equitymaster Agora Research Private Limited (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA or Canada, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here
. The performance data quoted represents past performance and does not guarantee future results.SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.
Equitymaster Agora Research Private Limited. 103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: email@example.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407