Positive Net Cash
Every investor's objective is to find undervalued investment and then sell it when it reaches fair value. To locate the fair value of a common stock, we will need to predict the gains generated by the inventory over a time period. This prediction might not be accurate. After all, nobody can know the future with 100% certainty. When things suddenly turn ugly, investors will need to safeguard themselves against capital losses. The way to decrease this threat is by investing in companies with positive net cash.
Net Cash is the difference between money & short-term investments together with the quantity of long term debt. We can find this 3 items on the balance sheet of each provider. A whole lot of times, an individual can include long term investment as money. Long term investment may include tools such as 18 month Certificate of Deposit or treasury bond maturing one year or more. To be on the safe side, let's consider just short-term and cash investments.
You may wonder why we don't subtract short-term liabilities such as accounts payable. Fantastic question. The main reason is that accounts receivable is normally utilised to buy inventories. Some of the earnings can be tied up in accounts receivable. In normal business performance, both of these things may be used to cover short-term liabilities. There are of course exceptions such as banks in which they utilize short-term liabilities ( clients' deposit) to provide loans (long-term investments) to individuals or businesses.
Once we know why we specify net cash the way they are, we can then appreciate the role of it. Web Cash defines the financial structure of an organization. We can tell companies with strong financial structure by taking a look in its net cash position. Typically, investing in companies with positive net cash is not as risky.
As the term suggests, positive net cash means that the company has more cash in hand than long term debt. To put it differently, the business is less leveraged and less burdened with debt. It may pay its long term debt straight away if it needs to. This is the perfect way to leverage a small business.
All our sample portfolio stock selections have a positive net cash on their balance sheet. The reason is that when our prediction fails, the business is less likely to go bankrupt. When a company has lots of cash, it is able to incur losses until its company turn around.
Another reason is that firms with positive net cash is able to purchase assets on the cheap during economic recession. When the market is in a bad shape and losses are mounting, poorer companies tend to raise money by selling off its assets that are valuable. Firms with positive net cash will be there to purchase.
Finally, companies with positive net cash is able to buy back shares or give dividends when companies are bad. It's no surprise. They have more fiscal muscles than others to be more generous. This may benefit common shareholders like us.
There are a few investors that feel that firms with positive net cash aren't efficient. They conclude that companies should benefit from the power of leverage so that it can maximize shareholders' return. Well, their view isn't wrong. Buying companies with positive net cash may not offer you a 10 fold return in 1 year. Nonetheless, you won't lose all of your capital in one year . It's all your choice.