Endwave (ENWV) has cash of $66 million and total liabilities of just $5 million, yet the stock trades for just $24 million. The company does show losses; however, in recent quarters these losses have been small in comparison with what appears to be a gigantic margin of safety. But despite the large cash balance, investors who dig deeper into the company's financial statements would find that the margin of safety is not what it appears to be!
Many of Endwave's financial updates use a single line to represent shareholder's equity, but that can be misleading. This is because Endwave is financed by a large block of preferred stock which has a larger aggregate value than the company's common stock! Once this preferred stock is subtracted from the company's cash balance (since preferred stockholders are higher in the pecking order than common stockholders), the margin of safety reduces to a paltry sum. The company's quarterly losses now become a material issue, and if they continue, they can play a large role in further reducing the value of the common stock.
Stock screens and financial statement summaries such as those found on Yahoo! and Google can be useful in identifying companies trading at discounts to their intrinsic values. However, investors cannot buy on this basis alone. A careful reading of the company's audited financial statements, and notes to its financial statements, including the composition of the company's share capital, is imperative. Securities that rank ahead of common shareholders, not just liabilities, must be identified and accounted for before an accurate valuation of the common stock is possible.
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