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Negative Enterprise Value: Does It Really Mean Money for Nothing?

The enterprise value of a company is a measure often used to calculate how much it would cost to buy that company. Considered by many to be a more accurate representation of a company's value than simple market capitalization, enterprise value is calculated by adding the market capitalization and total debt of a company together, then subtracting its cash and cash equivalents.


This calculation makes sense in terms of the fact that when you buy a company, you must pay for its debt as well as its assets and earnings potential. Good companies will typically have enough net cash to avoid going bankrupt, while it's rare for a company to have low or nonexistent debt. When a company does have debt that is zero (or close to zero) and a steady stream of revenue, this can lead to a common anomaly in the enterprise value calculation - the negative enterprise value.

Simply put, a negative enterprise value means that a company has more cash than it would need to pay off any debt and buy back all its stocks in one go, if it really wanted to. No wonder it's called the takeover value; even though you would not actually be able to get a publicly traded company to pay you to take it, who wouldn't want to buy a company with a vault of cash in the basement?

Most of these companies don't maintain high negative enterprise values for long, since all that cash sitting there isn't really doing anything for the company or the shareholders, but this measure can be a useful assessment tool given the right circumstances.

Charles Schwab

Charles Schwab Corp. (NYSE:SCHW) is an investment management company with a market cap of $56.50 billion and an enterprise value of -$12.33 billion. It has no debt, a price-earnings ratio of 15.96, a three-year revenue growth rate of 15.7% and a three-year earnings per share without non-recurring items growth rate of 33.5%.

Charles Schwab is a well-known investment company that offers a wide range of products, from mutual funds and bonds to options and futures. Approximately 1.7 million people participate in its corporate retirement plan, and the total amount of client money invested in its proprietary mutual funds and exchange-traded funds currently exceeds $450.2 billion.

As with many companies that have a negative enterprise value, Charles Schwab may currently be undervalued. The stock price has been on the decline since 2018 despite consistently increasing revenue and net income (it was heavily overvalued in 2018, so the stock price decline can be largely considered a correction).

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The company has a GuruFocus financial strength score of 4 out of 10 and a profitability score of 5 out of 10. The low financial strength score is partially due to the company's equity-to-asset ratio of 0.08%, which ranks lower than 91.74% of competitors in the brokers and exchanges industry.

The equity-to-asset ratio of companies with a negative enterprise value is not always this low, but it is not surprising; both net cash and receivables are included in a company's total assets. Additionally, because Charles Schwab does not have any debt, it does not have an interest coverage ratio or an Altman Z-Score. Due to these reasons, when you search for companies with a negative enterprise value on GuruFocus's All-in-One Screener, you will see that many of them do not have a high financial strength score, as the metrics used to calculate this score are often missing or skewed due to these special circumstances.

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American Financial Group

American Financial Group Inc. (NYSE:AFG) is an insurance company that has a market cap of $9.64 billion and an enterprise value of -$36.025 billion. It has a cash-to-debt ratio of 1.89, a price-earnings ratio of 14.79, a three-year revenue growth rate of 4.7% and a three-year earnings per share without NRI growth rate of 14.1%.

The Cincinnati, Ohio-based holding company was founded in 1959. Originally having its roots in American Insurance Co., American Financial Group is primarily engaged in property and casualty insurance and the sale of traditional fixed and fixed-indexed annuities.

According to the Peter Lynch chart and the company's historical stock price relative to its revenue and net income, American Financial tends to trade at or slightly below its fair market value, never straying into massively overvalued or undervalued territory.

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GuruFocus has assigned the company a financial strength score of 4 out of 10 and a profitability score of 6 out of 10. It has a cash-to-debt ratio of 1.89, but no interest coverage ratio or operating margin, indicating that its debt is not due in the short term.

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In accordance with its excess of cash, American Financial has a three-year dividend growth rate of 12.1% and a dividend payout ratio of 0.22, topping 81.01% of industry competitors. There is plenty of room for future dividend growth, however, as the dividend yield is currently 1.55% and the company has issued more stock than it's bought in the past three years. On Nov. 4, the company declared a special dividend of $1.80 per share to be payed on Nov. 25 to shareholders of record as of Nov. 15. This marks the highest special dividend the company has ever paid; it is 30 cents higher than the 2018 special dividend.

The Hanover Insurance Group

The Hanover Insurance Group Inc. (NYSE:THG) is an insurance company with a market cap of $5.23 billion and an enterprise value of -$1.774 billion. It has a cash-to-debt ratio of 0.24, a price-earnings ratio of 12.54, a three-year revenue growth rate of -2.4% and a three-year earnings per share without NRI growth rate of -9%.

The Hanover Group provides various types of personal and business insurance. It offers tailored insurance coverage to meet different business needs at value prices. The company has received high reviews; 93% of customers saying they would recommend it to a friend, and it was ranked as the second-most reputable property and casualty insurance company in 2018 by U.S. Insurance RepTrak.

Unfortunately, in Hanover's case, the high customer ratings and negative enterprise value may not necessarily be able to contribute to stock price growth. Though the company is not as massively overvalued as it was in 2016, it is still slightly overvalued.

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The company's revenue and income have been increasing from 2017 to 2019 after suffering a drop from 2016 to 2017, which accounts for the company's negative growth rates. When combined with the negative enterprise value, Hanover's more recent revenue increases have been able to raise the stock price, resulting in mixed signals as to whether the company will be able to keep increasing value for shareholders.

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Hanover has a GuruFocus financial strength score of 4 out of 10 and a profitability score of 5 out of 10. Both its cash-to-debt and equity-to-asset ratios are 0.24, indicating the majority of its negative enterprise value comes not from cash, but from cash equivalents.

Compared to companies that have more cash than debt, a company that has more debt than cash is nowhere near as likely to return value to shareholders since it would likely have to convert some of its cash equivalents to cash in order to do so. Thus, when screening for companies that have a negative enterprise value, results could be improved by eliminating companies with a cash-to-debt ratio of less than 1 from the list. However, for negative revenue growth rates, a holistic approach might be in order, as a single bad year can skew results for this metric.

Disclosure: Author owns no shares in any of the stocks mentioned.

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This article first appeared on GuruFocus.