What Does "Trading for Less Than Cash" Mean?
"Trading for less than cash" means that a stock's market price is less than the cash on its books. In periods of market volatility, a stock's market price may suffer even if the business fundamentals are sound. Perceptive investors, such as Berkshire Hathaway chairman Warren Buffett and former Fidelity mutual fund manager Peter Lynch, regard these situations as possible buying opportunities for quality stocks at deep discount prices.
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History
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Peter Carbonara and others wrote in an October 2008 "Bloomberg Businessweek" article that famed value investor and author Benjamin Graham, who mentored Buffett, noticed during the Great Depression that a number of public companies were selling at a discount to the cash on their books. Graham noted that this phenomenon means the stock is either cheap or the company should be liquidated because of fundamental underlying problems.
Facts
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Cash per share is cash minus debt, divided by the number of shares outstanding. On Oct. 14, 2008, in the middle of the financial crisis, 29 U.S. firms and 185 foreign companies were trading below cash, according to Carbonara. Cash includes cash deposits and short-term liquid marketable securities, such as Treasury bills and other high-quality short-term bonds. However, these undervalued situations are not necessarily permanent: for example, the stock markets retraced most of the 2008 losses by the end of 2010.
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Significance
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A company that is trading at less than its cash value could indicate an oversold condition and a "tempting signal to buy," said Charles Wolf, analyst at mutual fund manager Needham & Co., to Carbonara. However, sometimes there is a reason for a stock's low-trading price. For example, Carbonara cites the high-debt load of ADC Telecommunications as the most likely reason for its depressed stock price. Management turnover, recent order cancellations, a new competitor entry and changing customer preferences might be other reasons a company's stock trades less than its cash value. Investors should, therefore, exercise caution and do research before investing in these stocks.
Strategies
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Investors should not rely on financial statements alone because they reflect historical data. For example, Carbonara cites the case of technology company Cypress Semiconductor whose cash position dwindled by half after it acquired another company and paid off some debt. Investors should, therefore, review relevant news since the last publication of the financial statements to get a more accurate read on a company's actual cash position going forward. Lynch suggested to former "American Association of Individual Investors Journal" editor Maria Crawford Scott that a price drop is an opportunity to add to a quality position at cheaper prices because these situations do not last long and it is difficult to find value stocks in a rising market.
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References
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