In finding a good investment candidate, I always emphasize on finding stocks below fair value and having a positive net cash. Today, let me emphasize the importance of positive net cash for your stock investment.

Net Cash is defined as the sum of cash equivalents, short term investment and long term investment subtracted with the firm's long term debt. You can find all these items on the balance sheet of a company. Quarterly balance sheet is preferred since it reflects the most recent condition of the firm. Here is the formula once again:

Net Cash : ( cash equivalents + ST investment + LT investment ) - LT Debt

Having positive net cash means that the company has more than enough cash to pay off its long term debt if it wants to. This is important because in lean times, cash is scarce or even leave the company's coffer if business deteriorates further. Let us revisited an article written back in September 2005 comparing three automakers suppliers; Magna International, Delphi and Dana Corp. These companies are the largest automaker suppliers in the US and they have business operations internationally. The similarities end there as both Delphi and Dana has a negative net cash of $ 1.97 Billion and $ 1.31 Billion respectively. Meanwhile, Magna spots a positive net cash of $ 533 Million.

Fast forward now, both Delphi and

Dana has announced a chapter 11 bankruptcy while Magna continues to produce profit of around $ 6.80 per share. What gives? These three companies are in the same industry and it is a hard time for the three of them. However, having positive net cash means greater flexibility which enables companies to thrive even during hard times.

I reckon that if both Delphi and Dana can turn their business around, their stock price will increase much faster than Magna. However, the chance of them turning around is slim due to their huge debt burden. When a company spots a huge negative net cash, it better profitable, or else it cannot service its debt and it will end up in bankruptcy. This is a high risk high reward scenario. The choice is up to you. So far, Magna has been the better choice in this case.

Tell Your Friend