Friday, February 26, 2010

Common Comes Last

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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Disclosure: None


Andrew said...

Another stock with this exact situation is (TSCM), as of a month ago it was trading at only a slight premium to net current assets with a historically profitable (only 3 years and not in 09) and cash flow generative operation.

The preferred stock on the balance sheet was listed at 55 dollars par value (which initially you would assume has some claim but doesn't appear to be the death blow at first glance)... check the footnotes and you find that that par value of the preferred is 10k per share which equates to 55M senior claim to common. Which basically equals the entire cash balance.

thanks for the blog I like your style, there aren't to many people out there who are willing to suffer the negative publicity and lower readership that comes with consistently detailing while particular equities are not good investments.

Anonymous said...

This is a very incompetent post. On January 21, Endwave bought back the preferred at a discount and now has about $30 million in cash, or $3 per share. Given that, why would someone post a story about the negative implications of the preferred on February 26?

Saj Karsan said...

Thanks, Andrew!

Hi Anon,

You are right: since the company's last financial statements, they have bought back the preferred shares. But note that this reduces the cash balance as a result! This post was not intended to be an update of Endwave's cash flow, but an illustrative post on how a margin of safety may appear to be there, but may not be depending on the presence of shareholder liabilities that are not formally classified as liabilities (i.e. preferred stock).

Chroma said...

I think the post on ENWV was clearly an attempt to alert readers to the perils of simply accepting the results of any screener. I had a similar post on ENWV back in December at

For clarity ENWV ended 2009 with $55.2 million in cash. According to their 8k dated 1/21/10 they paid $36 million to Oak Investment Partners for their Preferred shares thus reducing their cash position to $19.2 million. While they do have other assets one should be careful about calling someone incompetent when your own figures are inaccurate.