A few months ago, I embarked on a project I called The Financial Uproar Less Than Cash Index (or NAMBLA for short). I’d run a screen which identified stocks trading for less than the cash on their balance sheet, blindly buy all the stocks that fit the criteria, and then take all the gains to the imaginary bank. Because I’d be nuts if I’d risk actual cash on this hair brained scheme. Wil-E-Coyote strapping rockets to his roller skates was a smarter idea.
And in my haste to make a point, I realize that my screen had one major flaw. I hadn’t properly controlled for each company’s liabilities. If a stock trades at $1 per share, has $1.50 in cash and has 56 cents of liabilities (debt, underfunded pensions, deferred taxes, etc.) then it doesn’t really trade for less than the cash on its balance sheet. What I really needed to do was take 20 minutes per name and make sure the balance sheet was actually clean.
I might take the time to do that one day, but in the meantime I stumbled upon something that I found on the Twitter. I can’t remember who posted it originally but if you’re the person, feel free to claim credit in the comments. It’s about the returns investors would get by investing in companies with negative enterprise values.
The piece – by a guy named Alon Bockman, who looks like he’d be a blast to have at a party – breaks down returns that investors would have enjoyed by blindly buying negative enterprise value stocks by each country, and looks at results over 40 years between 1972 and 2012.
Before I get into it, let me further explain what a negative enterprise value stock is. You take a company’s cash position and subtract all debt. If that net cash level is still more than the share price, you’ve got a stock trading at a negative enterprise value. There won’t be very many of these when the market is high (like now) and there will be more once the market goes down.
Okay, enough stalling. How did negative enterprise value stocks perform? Really well, actually.
Bockman’s first set of results come from the United States. There were more than 26,000 total opportunities to buy negative enterprise value stocks. The model assumed you bought and then held on for a year, and then sold. If the stock languished in negative enterprise value land for six months, it assumed you bought and sold six times. The result was an average return of each opportunity of more than 50%.
Here’s his chart.
A couple of takeaways:
1. Notice how the vast majority of the opportunities came in the micro cap space? That’s not by coincidence. Companies with less than a $50 million market cap are too small to be noticed by any institutional investors.
2. And total return was much higher for micro caps. Because when small stocks get beaten up, they get really beaten up. I continue to stress you all should be buying small cap stocks. There’s no way you can consistently beat the market buying large caps. None. Do you really expect you know more about Apple than Goldman Sachs does? Don’t delude yourself.
Bockman goes one step further, and looks at negative enterprise value stocks over a number of different countries, over the same time period. The results are a little surprising.
It’s interesting how certain countries which would be identified as less stringent on the regulations (Israel, Cayman Islands, Hong Kong) do better than Canada or the U.S. No surprise China is so low, considering all the reverse takeover frauds that plagued the country during the last few years. Not exactly sure why the Netherlands did so poorly, but it seems like a good excuse to blame a stoned guy riding a bike, so let’s do that.
You could try to replicate these results. I don’t even think it would be that hard. But you’d be investing in some stuff that looked like absolute trash on the surface. Instead, I’d just take this as confirmation that companies with lots of cash on their balance sheets are good, and if you can find some that have lots of cash and a reasonable underlying business, they should be purchased. With markets as high as they are, those stocks are getting tougher to find.