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I had completely forgotten about a test portfolio that I started in March: Negative Enterprise Value Stocks.

In March, I was thinking about what other strategy would perform very well in a bull market. Back then net nets were plenty and I knew that extremely cheap stocks would do well as prices had to revert to the mean eventually. But my concern was that if the market rose too quickly, the universe of Graham’s net nets would disappear just as quickly and a new strategy would be needed.

Enter cheap stocks in the form of Negative Enterprise Value.

Negative Enterprise Value Formula

(Magic Formula Investing Definition)

Enterprise Value = Market Capitalization + Total Debt – Excess Cash

Excess Cash = Total Cash – MAX(0,Current Liabilities-Current Assets)

(Standard Formula)

Enterprise Value = Market Capitalization + Total Debt – Cash and Equivalents

Since enterprise value accounts for debt and subtracts the excess cash from the equation, if the formula above results in a negative number, the conclusion is that the company is loaded with excess cash, hence a cash rich company trading for less than its value.

If you look at NCAV stocks in the Graham cheap stock screen, you will see that many companies are loaded with inventory or receivables, but a company with negative EV will have a higher percentage of assets in cash, hence a higher quality of assets.

Market Crushing Strategy

Like net nets, I’m convinced that in a bear market, negative enterprise stocks will outperform the market by a big margin. I admit the actual test portfolio has a lot of flaws but my logic tells me that a company with more cash than its market cap and total debt combined is a formula for out-performance.

Below is the table of negative EV stocks' performance since March. Remember that I had completely forgotten about this so I didn’t sell or add to it. These were just a group of stocks that I felt had valid businesses that were not going to go bankrupt in the recession.

Negative Enterprise Value Stocks

Ticker May 25 2009 Dec 31 2009
TUES 523.81% 293.65%
GSOL 69.75% 82.63%
ZINC 65.16% 205.97%
HSII 34.22% 120.15%
TLF 27.37% 94.74%
BBW 10.46% 20.92%
DIVX -2.91% 13.10%
Enterprise Stocks Combined 103.98% 118.74%
S&P500 23% 58.03%

Stocks Entering 2010 at Negative EV

2010 Negative EV Stocks

Ticker Market Cap Enterprise Value Price
HCII 50.6 -38.6 $7.80
ATV 140.1 -1.5 $4.73
ACTS 207.2 -0.016 $2.41
OTCQB:CAPS 29.3 -10.5 $0.72
CHCG-OLD 25.8 -2.5 $0.50
CMM 62.7 -110.3 $2.63
FMCN 2100 -209.1 $15.85
FOLD 89.8 -1.1 $3.97
GRVY 45.3 -12.7 $1.63
IDT 75.6 -17.4 $4.85
INSM 96.2 -18.7 $0.77
MTE 967 -37.6 $3.07
OTCPK:MYRX 123.2 -33.5 $5.03
NCTY 202.3 -79.8 $7.22
NINE 62.2 -30.1 $1.74
PDII 68.5 -7.8 $4.82
QXM 171.3 -44.3 $3.66
SCMRD 593.8 -49.4 $20.91
TRID 117 -27.7 $1.86

FMCN, CMM, NCTY, SCMRD, MYRX look very cheap indeed.

I’ve put this exact list of stocks in an investment tracking portfolio so it will be interesting to see the performance of this group at the end of the year.

Disclosure: I own INSM, GRVY, PDII at the time of writing.