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.
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)
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|
|Enterprise Stocks Combined||103.98%||118.74%|
Stocks Entering 2010 at Negative EV
2010 Negative EV Stocks
|Ticker||Market Cap||Enterprise Value||Price|
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.