What it means
Market value, also called market capitalisation, is the share price multiplied by the number of shares in issue. Cash on the balance sheet is the company's money in the bank and in very liquid investments.
If the first number is lower than the second, the market is effectively valuing the operating business at less than zero. This can happen for several reasons.
Investors may expect the company to burn through its cash with continuing losses, or they may worry that management will waste it on poor acquisitions. There can also be trapped cash held in foreign subsidiaries, or large hidden liabilities such as lawsuits or pension deficits.
Analysts usually refine the comparison by looking at net cash, which is cash less all debt, and then dividing by the number of shares. A more careful version also adjusts for obligations such as lease payments, tax on repatriating profits and the cost of closing the business.
A company trading below net cash per share is sometimes called a net-net candidate. Value investors are drawn to such situations, hoping the market will eventually recognise the cash, or that an activist or acquirer will force a return of capital through dividends, buybacks or a sale.
The approach has a long history but needs patience and careful checking of what the cash really is. The risk is that a business trading below cash may deserve its low price.
If the company keeps losing money, the cash pile shrinks each quarter, and the apparent bargain disappears. Reading cash flow statements and the notes about restrictions is therefore essential.
For non-specialists, the phrase also appears in news about technology start-ups after a funding boom, when share prices fall faster than cash balances. It is a useful sign to look at the balance sheet before reaching a conclusion.
In practice
Real-world examples.
Example
A software company raised funds in a boom and is now losing money, yet its share price has dropped below its cash balance. An activist investor argues that the board should return the cash and wind the business down. The board agrees to a review.
Example
A retailer with large cash holdings in a country that restricts transfers sees its shares trade below consolidated cash. Analysts point out that the cash cannot easily be paid out as dividends. The discount reflects that trapped cash is worth less than cash in a head-office account.
Example
A small biotechnology firm has $60,000,000 of cash and a market value of $50,000,000 after a failed trial. The market expects the firm to spend its cash on further research that may not succeed, so it prices the shares below what the bank balance alone implies.
Formula
Calculation
Net cash per share = (cash and short-term investments - total debt) / shares outstanding
Premium or discount to net cash = (share price - net cash per share) / net cash per share
Suppose a company has $120,000,000 of cash and short-term investments, $20,000,000 of debt and 50,000,000 shares. Net cash per share = (120,000,000 - 20,000,000) / 50,000,000 = $2.00. If the shares trade at $1.60, the discount is (1.60 - 2.00) / 2.00 = -20%. The market capitalisation is 1.60 x 50,000,000 = $80,000,000, which is $20,000,000 below net cash of $100,000,000.Case study
Seen in the real world.
Larkspur Devices is a fictional electronics designer used for illustration only. After a product recall, its shares fell until its market value sat at $90,000,000, while its balance sheet showed $110,000,000 of cash and no debt. A small fund spotted the gap and began buying.
The fund investigated and found that the cash was freely available and that the recall liability was modest. It proposed a special dividend, and over the following year the board returned part of the cash and the share price recovered. In this illustrative story, the lesson is that the analysis of cash quality came first and the trade followed.
Watch out
Common mistakes.
- Ignoring debt. A company with $100,000,000 of cash and $90,000,000 of debt is not really trading below cash if its market value is $80,000,000.
- Assuming the cash belongs to shareholders in full. Cash may be needed for operating costs, restricted by lenders or located in places where it is costly to move.
- Treating it as a guaranteed bargain. If the business keeps burning cash, the cushion can vanish and the shares may fall further.
Questions
People also ask.
Is trading below cash the same as trading below book value?
No, book value includes all assets and liabilities, while this comparison looks only at cash and cash-like items.
Why would a market ever allow this?
Pessimism about losses, fears of poor capital allocation and uncertainty about hidden liabilities can outweigh the visible cash.
What can bring the price back up?
A dividend or buyback, an acquisition offer, a turnaround in the business or an activist campaign can all close the gap.
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