What are Marketable Securities
Marketable securities are liquid financial instruments that can be quickly converted into cash at a reasonable price. The liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.
BREAKING DOWN Marketable Securities
Businesses typically hold cash in their reserves to prepare them for situations in which they may need to act swiftly, such as taking advantage of an acquisition opportunity that comes up or making contingent payments. However, instead of holding on to all the cash in its coffers which presents no opportunity to earn interest, a business will invest a portion of the cash in short-term liquid securities. This way, instead of having cash sit idly, the company can earn returns on it. If a sudden need for cash emerges, the company can easily liquidate these securities. Examples of a short-term investment products are a group of assets categorized as marketable securities.
Marketable securities are defined as any unrestricted financial instrument that can be bought or sold on a public stock exchange or a public bond exchange. Therefore, marketable securities are classified as either a marketable equity security or a marketable debt security. Other requirements of marketable securities include having a strong secondary market that can facilitate quick buy and sell transactions, and having a secondary market that provides accurate price quotes for investors. The return on these types of securities is low, due to the fact that marketable securities are highly liquid and are considered safe investments.
Marketable Equity Securities
Marketable equity securities can be either common stock or preferred stock. They are equity securities of a public company held by another corporation, and are listed in the balance sheet of the holding company. If the stock is expected to be liquidated or traded within one year, the holding company will list it as a current asset. Conversely, if the company expects to hold the stock for longer than one year, it will list the equity as a non-current asset. All marketable equity securities, both current and non-current, are listed at the lower value of cost or market.
If, however, a company invests in another company's equity in order to acquire or control that company, the securities aren't considered marketable equity securities. The company instead lists them as a long-term investment on its balance sheet.
Marketable Debt Securities
Marketable debt securities are considered to be any short-term bond issued by a public company held by another company. Marketable debt securities are normally held by a company in lieu of cash, so it's even more important that there is an established secondary market. All marketable debt securities are held at cost on a company's balance sheet as a current asset, until a gain or loss is realized upon the sale of the debt instrument.
Marketable debt securities are held as short-term investments and are expected to be sold within one year. If a debt security is expected to be held for longer than one year, it should be classified as a long-term investment on the company's balance sheet.
Using Marketable Securities in Fundamental Analysis
Marketable securities are evaluated by analysts when conducting liquidity ratio analysis on a company or sector. The liquidity ratio measures a company's ability to meet its short-term financial obligations as they come due. In other words, this ratio assesses whether a company can pay its short-term debts using its most liquid assets. Liquidity ratios include:
1. Cash ratio:
Cash Ratio=Current LiabilitiesMCSwhere:MCS=Market Value of Cash and Marketable Securities
The cash ratio is calculated as the sum of the market value of cash and marketable securities divided by a company's current liabilities. Creditors prefer a ratio above 1 since this means that a firm will be able to cover all its short-term debt if they came due now. However, most companies have a low cash ratio since holding too much cash or investing heavily in marketable securities is not a highly profitable strategy.
2. Current ratio:
Current Ratio=Current LiabilitiesCurrent Assets
The current ratio measures a company's ability to pay off its short-term debts using all its current assets, which includes marketable securities. It is calculated by dividing current assets by current liabilities.
3. Quick ratio:
Quick Ratio=Current LiabilitiesQuick Assets
The quick ratio factors in only quick assets into its evaluation of how liquid a company is. Quick assets are defined as securities that can be more easily converted into cash than current assets. Marketable securities are considered quick assets. The formula for the quick ratio is quick assets / current liabilities. (For related reading, see "Common Examples of Marketable Securities")