Thursday, November 17, 2011

Cash For Granted

As investors, we often take a company's cash and short-term securities for granted. Accounts receivable may be written down (who knows if all customers will pay, especially that major one!), inventories may not be worth their full value, but cash equivalents are worth their book value, right? Maybe they are most of the time, but that's not necessarily true.

It's important for investors to know what kind of securities these companies are considering short-term investments. For example, consider Ambassadors Group, a company with a market cap of $80 million with $53 million of cash and short-term investments on hand. Clearly, the "cash" component is a big part of this company's current value.

But $47 million of these cash and investments are in municipal securities! It's quite possible (and even likely) that the company can recoup all of this money. Under most circumstances, it will. But this is far from assured. To chase some extra yield (and show a lower tax rate, since interest from municipal bonds accrues tax-free), the company may be taking on significant downside risk. Few details about the make-up of these bonds (e.g. which municipalities) are provided. As such, the investor can only hope that these funds have been lent to responsible borrowers. This is not the case for all municipalities; consider Birmingham, Alabama, which just voted to declare bankruptcy.

Investors can't just skip over the "short-term securities" line of a company's balance sheet. Figure out what they are, so that you can determine if you're comfortable with the investments. This is especially important when these investments play such a prominent role in a company's valuation, as they do here.

Disclosure: No position


cash pension in said...

at least there is some cash available

JerryMcM said...

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