Trading Below Cash Definition

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Trading Below Cash Definition

What Is Trading Below Cash?

When a company’s entire share value is less than its cash minus debts, it is said to be trading below cash. Trading below cash happens when a company’s market value is less than its cash on hand, which is most probable when growth prospects are weak.

Stocks selling below cash might be appealing to value investors in certain situations; yet, such a firm may be mired for fundamental reasons.

Key Takeaways

  • When a company’s stock price implies a market value that is less than the firm’s total cash holdings on its balance sheet, it is said to be trading below cash.
  • Investors may undervalue a firm if they feel the burn rate due to expansion is too high to maintain it, or if the full cost of its liabilities is unknown.
  • Stocks that trade below cash may be good bargain investments.
  • However, they may often foreshadow future problems for the organization.
  • Any financial asset that seems to be selling below its fair or inherent worth may also be referred to as trading below cash.

Understanding Trading Below Cash

Depending on the company’s prospects, trading below cash may or may not be seen as a negative. If a firm is undergoing a turnaround, its stock may be selling below cash while still having the potential to prosper in the future. The inverse may also be true: if a firm is trading below cash with limited growth prospects, this might indicate that it is in danger.

The ancient adage goes, “even a castle isn’t worth much if it’s on fire,” which means that a company’s financial reserves aren’t nearly as significant as how quickly the money is spent (the burn rate).

Any asset or financial instrument that looks to be selling below its inherent or fair value is frequently referred to as trading below cash.

Value Traps and Market Conditions

A firm selling for less than its net cash per share seems to be an obvious bargain purchase. However, if investors do not look further, they may fall victim to a typical value trap. This happens when a stock trades at low valuation measures such as earnings, cash flow, or book value multiples over a prolonged period of time in comparison to historical valuation multiples or a market multiple. When investors purchase into an apparently inexpensively priced firm at low prices, the stock continues to stagnate or sink lower. Things may sometimes become worse before they get better—and sometimes they never get better.

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Companies seldom trade below their cash values during a robust bull market. However, similar circumstances do happen during significant corrections, such as the 2008 housing crisis. Certain industries, such as the “tech disaster” of 2000-2002, might also see abrupt reductions in market capitalization. Sectors and industries on the verge of the “next greatest thing” may trade below cash value at times. Recent examples include cloud-based SaaS applications, social networks, and, increasingly, everything related to artificial intelligence.

Reasons for Trading Below Cash

Stocks, as predicted, seldom trade below their cash value. They may, however, do so in specific instances, such as those stated below:

  • Investors are prepared to pay greater values for equities in optimistic markets, thus they seldom trade below cash value. During a prolonged bear market, however, when uncertainty prevails and values plummet, it is not uncommon to discover a large proportion of companies selling below cash value. For example, during an enormous sell-off in global financial markets in October 2008, more than 875 equities were apparently selling below the value of their per-share cash reserves.
  • Stocks selling below net cash may be concentrated in a single industry or sector if investors are highly pessimistic about the future of that business. Following the “tech disaster” of 2000 to 2002, for example, a number of technology companies were selling at a discount to the value of their net cash holdings.
  • A stock may also trade below its cash value if the firm works in a sector with a high “burn rate” (the pace at which capital is burned up for operations) and an unclear reward, such as biotechnology. In such instances, the market may see the company’s cash level as just adequate for a few more quarters of operations.
  • Stocks may also trade below cash value when the valuation of assets and liabilities on the balance sheet is unknown. Because of this, a number of banks and financial organizations traded below cash value during the 2008 bear market.
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Value or Impending Failure

The fact that a stock is selling below its cash value may indicate that investors believe the firm is less valuable than it would be if it were wound up or liquidated (and the proceeds distributed to investors).This often reflects a highly gloomy assessment of a company’s future, which may or may not be warranted in the end.

A company selling below its cash value may be a real value stock if the pessimism surrounding its prospects is unjustified. This might happen when a firm is in the early stages of a turnaround and its business outlook is improving, or when a company is developing a medication or technology and investors are skeptical about its prospects of success.

A stock selling below its cash value may indicate approaching collapse if the firm is unable to attract new capital before its cash runs out or if there are large obligations that are not visible on the balance sheet (e.g. a pending lawsuit or environmental issues).

In most circumstances, a company selling at or below net cash per share is not always a good buy, and it is required to dig beyond the figures to determine the cause of the anomaly.

Best Time to Invest

It might be difficult to determine if a low-priced stock is a solid investment or a pricey value trap. However, there are several strategies that may be employed to get a better understanding of the issue. One method is to examine the company’s book value, particularly its net cash per share. This illustrates how much shareholders would get if a company went bankrupt and had to liquidate. A high net cash value per share would indicate a superior investment.

Another statistic to consider is a company’s enterprise value (EV), which is comparable to market capitalization but also considers debt on the balance sheet. In other words, it computes the whole net worth of the firm. A low or negative enterprise value may be a warning sign.

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Once an investment has been chosen, it may be prudent to invest in companies that are selling below their cash value when general market sentiment is optimistic and equities are in a strong bull market. This allows you to catch the general trend.

Example of Trading Below Cash

A corporation with $2,000,000 in cash reserves, $1,000,000 in outstanding obligations, and a total market capitalization of $650,000 is an example of trading below cash. Its cash reserves minus liabilities equal $1,000,000 ($2MM – $1MM = $1MM), yet its stock is only worth $650,000.

What Is the Difference Between Market Capitalization and Equity?

Market capitalization (or “market cap”) is a company’s valuation based on the total price of all of its outstanding shares. While shares reflect a company’s equity, the market price may vary from the accounting value. Entire assets minus total liabilities equals equity.

What Is the Cash Value of a Stock?

A stock’s cash value, or net cash value, is defined as a company’s cash and equivalents less its debt divided by the total number of shares outstanding. It indicates the amount of cash accessible to shareholders in the event of a liquidation.

What Is Cash Value Added?

Cash value added (CVA) is a method of calculating a business’s profitability that considers positive cash flows created by the company. The Boston Consulting Group created it (BCG).

What Is a Good Cash Earnings Per Share?

Earnings per share (EPS) are always relative; nonetheless, higher EPS are usually preferable. A strong EPS is one that grows year over year and is higher than average when compared to industry peers. Cash earnings per share is a more conservative statistic that solely considers operational cash flows per share.

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