Here’s why its crucial to know the liquidation value of your stock

A company’s liquidation value is something we don’t think many investors think about an ASX stock. Unless they invest in distressed companies, in which case they may only hear about it from the media. But we think even ordinary retail investors need to know about this concept even for companies in good times. And in this article, we outline why.

What is liquidation value?

Liquidation value is an important concept that investors need to be aware of. It is a measure of how much money a company would be able to generate if it were forced into bankruptcy and liquidated. This includes both the tangible assets of the business, such as cash and inventory, as well as intangible assets like copyrights or patents.

Liquidation value calculations are usually based on current market values for assets and liabilities, including debt that would be owed to creditors in the event of bankruptcy. The assets are usually sold off piecemeal, so investors need to take into account the costs associated with this process such as legal fees and taxes.

Why is it important to know?

The liquidation value of a company is important because it provides investors with an idea of how much money they could potentially recover if the business fails. Knowing this number can help investors make more informed decisions when evaluating a potential investment opportunity. Even if your company is at no risk of liquidation (at least at the specific point in time when you’re looking into the number), it might be useful to know because if this is higher than the company’s current value – it clearly is undervalued.

By its very nature, it is inherently conservative estimate of a company’s potential worth. It does not take into account any potential future earnings from ongoing operations, which may be substantially higher than what could be generated from liquidation.

All this being said, there may be specific reasons why companies are undervalued – past reputational issues and poor conditions in its markets just to name a couple.

But what if the company does go belly up?

The liquidation value will be the capital – if any – that investors receive. But keep in mind that equity investors (retail and institutional alike) will rank right behind secured creditors. So they may not get anything at all.

Investors should also keep in mind that liquidation values can change over time due to market fluctuations. Therefore, it is important to stay up-to-date on industry trends and periodically reassess the liquidation value of a company’s assets and liabilities.

Something else to consider

While liquidation value can provide a guide as to what an investor may get – if any – it tells nothing about how long it might take to get this money. Or for that matter, if investors will get it at all. Equity investors will likely be behind ‘secured creditors’ which are debt investors with a formal security over investors’ assets in return for having lent them money.

In companies with ‘dual-class‘ share structures, investors with lower class shares may be behind those with higher class – this may differ from stock to stock and this is something you should do before buying as part of your due diligence.

An important concept, but just one of many to consider

Ultimately, liquidation value is an important concept that investors need to understand if they are going to make wise decisions when evaluating a potential investment opportunity. Knowing the liquidation value of a company can help investors assess their potential risks and rewards, making it easier to develop an optimal investment strategy.

But of course, there is no guarantee investors will receive such a value. It’ll all depend whether or not any money can be recovered from the selling of a business’ assets, and where abouts equity investors sit on the list of preferred creditors: They may be a fair way behind in the queue.

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