Wednesday, March 7, 2012

TD Ameritrade: When Cash Isn't Cash

A lot of time is spent discussing hidden liabilities (e.g. lease commitments, potentially damaging legal obligations etc.) on this site, as the value investor is always looking to protect his downside. But occasionally, it's also worth discussing assets that really aren't assets, so the investor doesn't assume a company owns something it doesn't. In this case, consider the cash balance of TD Ameritrade (AMTD).

TD Ameritrade provides securities brokerage services. As such, clients deposit their funds with TD Ameritrade which the company then classifies as an asset! So if you believe TD Ameritrade's balance sheet, it owns cash and short-term investments of almost $7 billion dollars against total debt of $1.3 billion. For a very profitable company with a market cap of just $10 billion, it looks like a steal.

But really only $1 billion of those cash and short-term investments belongs to TD Ameritrade. The rest are segregated (well, unless perhaps you're a client of MF Global) funds that really belong to the client. The company can earn some really tiny fees on this cash, but that's about it; it will never be used for buybacks or dividends.

You wouldn't know this if you quickly scanned the company, and this would cause you to severely overvalue this potential investment. Always read the notes to the financial statements; here's what TD Ameritrade writes in its first note to its financial statements in its annual report:

"Cash and investments segregated in compliance with federal regulations consist primarily of qualified deposits in special reserve bank accounts for the exclusive benefit of clients"

Disclosure: No position


M said...

One must be careful of this in banks, brokers, and Life/Health Insurance companies. Especially the last one, as segregated accounts (which usually reference variable annuity and whole life products) can make up a substantial portion of company assets, up to 50%. On the bright side though, this will bring down the stated leverage ratios because the assets/liabilities are matched off one for one in these accounts.

Anonymous said...

Unless their like MF Global in which case cash IS cash

Anonymous said...

Saj, Is this an industry practice or aggressive accounting?

Saj Karsan said...

Hi Anon2,

No reason why those have to be mutually exclusive! Easy to check if it's industry practice, though, by taking a look at how competitors do it.