All investors should develop some sort of mental checklist when picking stocks to buy. I personally look for companies with a large and growing addressable market, strong revenue growth, and a business that can scale into more profitability over time. But the bullet point from my investing checklist that I wish to discuss today is cash: I love companies with a strengthening cash position.
A significant cash position is something that can be found easily using a stock screener. That's how Riskified (RSKD 1.03%), 23andMe (ME -4.66%), and Poshmark (POSH) all came across my radar for the purpose of this article. Even though these three stocks are loaded with cash, here's why investors should dig deeper in each case.
Image source: Getty Images.
Why companies with cash are important
Having cash in hand is a wonderful advantage for businesses. During lean times, they can weather storms efficiently. Moreover, they can acquire competitors, buy back stock, or pursue new ventures. And all of these options can create shareholder value.
However, companies differ greatly in size -- a lot of cash for one company is minuscule for another. But these three stocks have a lot of cash relative to their market capitalizations -- the total value of the company -- as the chart below shows.
| Company | Cash, cash equivalents, short-term investments | Market cap | Cash to market cap |
|---|---|---|---|
| Riskified | $534 million | $1.46 billion | 37% |
| 23andMe | $701 million | $3.58 billion | 20% |
| Poshmark | $589 million | $1.52 billion | 39% |
Data from company filings. Market caps from Yahoo Finance and as of Dec. 7.
Although 10% is an arbitrary number, seeing that each of these stocks hold cash positions of more than 10% of their respective market caps should catch the eye of investors. No one can have a true formula but these positions certainly warrant research.
The cash-flow context
Every company's valuation needs to be understood in context. And one important piece of context is the company's cash-flow situation.
Image source: Getty Images.
For 23andMe, its operations aren't generating cash. In the second quarter of its fiscal 2022 (period ended Sep. 30), the company recorded a $16.5 million operating loss on $55.2 million in revenue. While that was a year-over-year improvement, these are still steep losses, meaning it could be tapping into its excellent cash position just to run its business.
The nature of 23andMe's core business explains its operating losses. Genetic testing kits aren't extremely high-profit margin -- there's a lot of costs associated with sequencing the human genome. Moreover, the space is competitive and 23andMe has sales-and-marketing expenses: $13.6 million in Q2 alone. That's a whopping 25% of its revenue.
Don't write off 23andMe yet. With each genetic test kit, it's adding to its genetic dataset that can be monetized by partnering with pharmaceutical companies to create new drugs in record time. It's not something that's really panned out to date. But the company's strong cash position is allowing it to continue plowing ahead with this plan that could bring in record profits if successful.
Image source: Getty Images.
Investors need some addressable-market context too
In stark contrast to 23andMe, clothing resale company Poshmark has a solid cash position -- and it's increasing. Through the first three quarters of 2021, the company has generated $68 million in cash from operations. This strong cash flow is thanks to how profitable its business has been.
Poshmark is a social marketplace for secondhand clothing and accessories. Third parties sell items from their own closets, meaning Poshmark doesn't hold any inventory -- it simply provides the marketplace. Because of this, its gross profit margin is very high -- 85% in the third quarter.
Poshmark has a substantial cash position, and its high-profit business is only strengthening it. The question now is what Poshmark will do with all this money. Rival business ThredUp believes this market will double by 2025, reaching $77 billion. Therefore, Poshmark is logically focused on growth. Still, there are questions about Poshmark's growth potential.
Consider that over the past four quarters, Poshmark has spent a total of $132 million on marketing. During this time, its active customer count grew by 17% to 7.3 million. That's only a little more than one million new active customers over this period. This suggests that Poshmark is either inefficient when it comes to marketing or (in contrast to ThredUp's study) there are simply not many people interested in what Poshmark has to offer. Inefficient marketing can be easily fixed but, weak consumer demand can't.
Image source: Getty Images.
The best buy of these three stocks
23andMe is an interesting opportunity if its genetic data can help develop a landmark drug. But the risk is there's no way to know if that will happen or how long it will take. With Poshmark, there's a risk that its market might not be as big as some investors hope, limiting its growth potential.
Then there's Riskified. Riskified stock dropped more than 50% in November alone, as the company's third-quarter financial results disappointed investors. The reaction was understandable: Riskified's software is supposed to detect fraud for e-commerce companies. Yet it appeared as though its software didn't do a great job in Q3, which hurt its profits and called the long-term investing thesis into question.
That said, keep in mind that Riskified has only captured around 2% of the multi-trillion dollar e-commerce market. And global e-commerce sales are expected to roughly double over the next several years. With a market cap of just under $1.5 billion, Riskified stock has substantial upside opportunity if its software can improve and attract new customers.
Riskified reported a $23 million operating loss in Q3, so the business is burning some cash. Nonetheless, it's not in danger of needing any additional funding anytime soon. Holding over $500 million in cash, it has ample resources to do whatever it needs to fix potential problems in its software.
Riskified isn't a surefire way to make money -- stocks never are guarantees. However, given its large market opportunity, its small-cap valuation, and its deep pockets, I believe it's a stock worth owning in a diversified portfolio.
