‘Number one, cash is king…number two, communicate…number three, buy or bury the competition.’ – Jack Welch, former Chairman of General Electric
Jack Welch knows a thing or two about running a successful business. In the twenty years that he ran GE, the share price increased forty-fold.
Welch’s number one rule was: ‘cash is king’.
Today, cash is more important than ever.
Checking a company’s kitty will not only help avoid a disaster, but it will also help you identify the better stocks on the market…
Cash is lower out there in small-cap land than ever before. Some just won’t make it. Many are running on fumes and will inevitably hit the wall.
But at the other end of the spectrum, there are a few with a surprisingly big wedge of dough to their names.
So far, my research has pulled up a cluster of small-cap mining stocks with so much cash that the cash balance is greater than their market cap.
You read that right. The market is valuing the company at less than its bank balance.
The Beauty of Small-Cap Stocks
That makes no sense at all of course. How could a $45 million bank balance be valued at $28 million by the market? In effect, investors can buy a dollar for just 62 cents!
I’d like to hear anyone who believes in markets being efficient explain this one. This is the beauty of small-cap stocks: with less liquidity, they trade illogically, and so can set up ridiculously easy buying opportunities.
When a stock is trading for less than its cash balance, you’re getting everything else for free as well! The resource, the infrastructure, the mine, the equipment, and so on…
It’s amazing these opportunities exist, but then again, not many people can be bothered crunching the numbers when it comes to small cap resources. I enjoy it, but then I always was an exciting bloke.
But that’s not the only stock with a cash stash bigger than its market cap. Another small-cap stock I spotted has $99 million in cash, yet has a market cap of just $55 million.
And even after factoring a bit of debt, it’s still trading well below ‘net cash’. There are plenty of others in a similar situation. Here are a few more:
So Why Does Any of This Matter?
Easy: because it’s tough as all hell to raise cash right now.
There are almost a thousand resource companies clamouring for cash from investors who basically don’t want to pay up.
And it’s getting tighter.
In the first four months of 2011, the total amount of cash raised was $11.5 billion.
In 2012 it fell to $8.8 billion.
And in 2013, the total so far has been just $7.5 billion.
You can see the trend. The purse strings are closing.
So having a stack of cash is an enviable position. Firstly, it enables survival. And secondly, like Jack Welch said, it means you can buy the competition. These cashed up stocks will be able to pick up some great companies, or their assets, for a fraction of their true value.
This is the right time to run this kind of analysis: right as the mining sector is at its low point. Last time I ran these numbers to see what came up was back in 2009. That’s when the resource sector was on its knees. The stocks with cash went on to increase by 60% on average in a few months.
One stock went one better than that: it gained 2,000% in the next few years.
So it’s worth spending a bit of time to trawl through the entire sector and see what comes up!
Looking at cash is just one part of the analysis of course. There’s a long checklist of things I like to run through as well.
And if the market cap is below the cash balance, is there any obvious reason why? Maybe the stock is stuck in a legal situation, or can’t get its environmental permit, or perhaps the commodity it’s looking at mining has crashed in price.
Another reason these stocks are trading for below cash value is that investors assume the company will spend the cash. Conservative investors would rather wait to see what the company does with the money before buying shares.
You can hardly blame them, given the way the market is right now.
But if there is no obvious reason why the stock is trading at a sub-cash discount, it could be the easiest profit opportunity waiting for you anywhere in the resource sector.
Resource Stocks May Finally Be Starting to Turn
For two months now the Metals and Mining index has held its ground.
Last week it fell, but only lost half of the huge gain it put in the week before when it finished up by 9.44% (Friday close to Friday close). This was its biggest percentage change over a week for more than four years.
Click to enlarge
This huge move was a good signal to watch out for better times ahead for mining stocks. This is still the cheapest sector of the ASX by far.
It’s the polar opposite to the banks, which have looked ridiculously expensive for a while. I suspect the falling Aussie dollar could trigger foreign investors to whip their money out of the banks, after doing well on both the stock price and the currency.
So if you want a cheap sector that’s starting to grind higher, resources are a good bet. And if you want to bet on some big moves, these cashed up small-caps could be the best bet of all.
Dr Alex Cowie
Editor, Diggers & Drillers
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