10 shares with large cash piles that might be too cheap

Stock screen expert Ben Hobson has scoured the stock market for cash-rich companies that may be undervalued. Here’s what the screen reveals.

With many share prices falling sharply this year, investors with an eye for a bargain will be watching with interest. After all, market-wide sell-offs can present the chance to buy shares in good companies at knockdown prices.

But one factor worth watching closely at a time like this is the all-important subject of cash - and how a company’s cash position can make its valuation slightly misleading. Read between the lines and you’ll be able to avoid problems and spot opportunities.

Hunting for hidden cash

To understand why cash is important, it’s worth remembering the mechanics of the popular valuation tool, the price-to-earnings (PE) ratio. A PE tells you the relationship between a company’s price per share and its earnings per share. The higher the ratio, the more expensive the share will appear.

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But a big variable in the PE is that, while a company’s valuation ought to reflect the cash it holds, that’s not always the case. Don’t forget that the ‘price’ part of the PE ratio is very much driven by the mood of the market. In good times you can’t always rely on the market adequately pricing-in positive cash. But in a bear market, things get even less certain.

With parts of the market very much in bear territory, there is a possibility that some cash-positive firms are being caught up in the widespread selling and becoming undervalued as a result - without it showing up in their PE ratios.

This is important because cash is likely to be an increasingly big advantage for firms having to contend with rising costs and the possibility of a recession.

Why some companies have cash piles

They say that cash is king. And there is no doubt the market often pays a premium for firms good at generating cash, with no (or low) debt and lots of financial firepower. It is also a useful position to be in as debt becomes progressively more expensive and returns on cash improve significantly.

But there are other reasons why a firm might have lots of cash. It could be that money has been paid by customers before the firm has had to pay its suppliers. It could be that it has built a cash pile to fund growth plans or make an acquisition. It could also be that it has issued equity to raise funds.

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For the investor, telling the difference means looking for those firms that are profitable, with positive earnings that have grown in recent years. Genuine cash strength is likely to be found in companies with positive, growing cash flow from operations. It’s important to see that net cash balances have grown year-on-year as well.

How cash and debt can impact the PE ratio

Having found companies where profits and cash are both positive and growing - and that the company has a net cash position - you can then look at how the PE might be impacted.

To adjust the PE, the ‘price’ side of the ratio is calculated using the firm’s enterprise value, which adds together the market cap and net debt (deducting any cash). You can now compare the regular PE and the cash (or debt) adjusted PE to see the difference in valuations.

Here is a screen that shows how this works:

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These companies have all seen positive and growing earnings and cash flow over the past year and their net borrowings are all negative, which in accounting terms means that they have ‘net cash’. Relative to the FTSE All Share index, a number of them have also seen their shares decline substantially in value.

In terms of comparing their regular PE and cash-adjusted PE ratios, all the stocks here are cheaper when adjusted for the cash that they hold. It’s the investor’s job to decide whether - on a PE basis - the market is getting the valuation wrong. If you were going in search of pricing discrepancies, this is one technique you could use to find them.

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In terms of sector, the results are mixed: firms like advertising tech firm Tremor International Ltd (LSE:TRMR) and LBG Media Ordinary Shares (LSE:LBG), the media company behind Ladbible, are both consumer discretionary industry stocks. They have exposure to consumer spending, which is currently under a lot of pressure.

There are also a number of mining shares here, which have seen their prices hold up well over the past year. Among them are Atalaya Mining (LSE:ATYM), Griffin Mining Ltd (LSE:GFM), South32 Ltd (LSE:S32) and Hochschild Mining (LSE:HOC). But even with these companies, there is an indication that the market isn’t giving them credit for the cash they hold.

For the investor, these clues are perhaps a starting point to track down parts of the market that are subject to mispricings that could be a buying opportunity once confidence begins to return.

Ben Hobson is a freelance contributor and not a direct employee of interactive investor.