Analysis of Asset Allocation

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Fundamental Analysis: Working  Capital
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Working capital as another measure of liquidity

The working capital is defined like this:

Working Capital - Current Assets - Current Liabilities

As we have seen with the current ratio, the working capital is supposed to represent the free amount of liquid assets in a company. Some famous analysts (Benjamin Graham & David Dodd) were looking for stocks valued under their working capital (stock price lower than the working capital per share). This was supposed to limit the downside risk of their investments.

Because the companies have also long term debts they have to reimburse, a more severe test has been used as well. This test is built by subtracting the long term debts from the working capital. This measure is called the net-net working capital

The ideal situation is to purchase stocks priced below their net-net working capital per share. Unfortunately, in a strong market, only the stocks that have poor perspectives, are traded below their net-net working capital but exceptions can happen!

But all is not around liquidity. You have other ratios that measure the financial health of the company and that should be looked as well.

 

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