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Liquid Assets vs. Liabilities

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By FreeCashFlow0714
April 16, 2008

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Is it just me, or does it seem that nearly every publicly traded company is leveraged rather than liquid? I've looked at the Yahoo key statistics of the companies in the S&P 600 smallcap value and S&P 400 midcap value indices, and more than 90% of the companies have more debt than cash. Many have a LOT more debt than cash. (The airlines, of course, look particularly gruesome.)

I like to see a company with enough liquid assets to pay off all the liabilities. This provides the company with breathing room in the event of setbacks, and it's also a reflection of good performance. When I appraise a stock, I always take net liquidity (liquid assets minus all liabilities) into account. If the company is net liquid (more liquid assets than liabilities), I add the difference to my appraisal. If the company is net leveraged (more liabilities than liquid assets), I subtract the difference from my appraisal. Of course, if you use net liquidity the way I do, there are certain industries you'll never buy, such as utilities. The net liquidity of airlines is more gruesome than the Texas Chainsaw Massacre remake movies.

John Train wrote in his books that at major market troughs, you can find stocks selling for less than the net cash value, which means you can essentially buy the company's operations for free. This sounds like such a fairy tale now given high market multiples and the rampant use of leverage.