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Counting Dollar Bills
June 09, 2014 | About: AAPL +0% MSFT +0% GOOG +0% CSCO +0% ORCL +0% QCOM +0%
HPQ +0% BRK.B +0% DE +0% BRK.A +0%
In corporate America, cash is king: Moodys estimated in January that
non-financial companies in the U.S. hold more than $1.5 trillion in
cash. Amazingly, a large percentage of these funds not only come
from one industry (tech), but from six companies: Apple (AAPL),
Microsoft (MSFT), Google (GOOG), Cisco (CSCO), Oracle
(ORCL) and Qualcomm (QCOM) account for more than one-quarter
of the total cash held by non-financial corporations in the U.S. To give
you an idea of what this means for these individual companies, heres
a look at their cash piles (and other cash-like assets) in comparison
to their market capitalizations:
Company Cash / Equivalents Market Cap % of Cap
Apple ~$150 billion ~$555 billion 27%
Microsoft ~$100 billion ~$340 billion 29%
Google ~$60 billion ~$375 billion 16%
Cisco ~$50 billion ~$125 billion 40%
Oracle ~$40 billion ~$190 billion 21%
Qualcomm ~$35 billion ~$135 billion 26%
Total / Average ~$435 billion ~$1.72 trillion 25%
As an investor, this brings up an interesting question: How should we account for this cash?
In my experience, this is addressed in two different ways: (1) avoided entirely, or (2)
backed out to calculate an earnings multiple excluding cash on hand. Clearly the first
approach is too pessimistic, even if you assume that much of the value of this excess cash
will be destroyed through expensive acquisitions but Im not sure that the second
The Science of
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approach does us much better.
From my perspective, the second approach suffers from two serious issues:
(1) Taxes: A recent article in the Sydney Morning Herald estimated that roughly $1 trillion
of U.S. companies cash on hand more than 60% of the total is trapped outside the U.S.
If companies plan on repatriating this cash, Uncle Sam will want his fair share; many are
holding out for a tax holiday, though the prospects appear grim. Even if you think a
repatriation tax holiday is near, you still need to account for the reduced tax rate (in 2004,
the rate was 5.25%).
(2) Time Value of Money: In the case of Microsoft (which Ill use as an example because
its the company from above that I know the most about), cash flow from operations has
averaged nearly $30 billion per annum over the past three years. Over that same period,
the company has spent about $14 billion a year on dividends and repurchases
(cumulatively), about $4 billion a year on acquisitions, and another approximately $3 billion
a year on capital expenditures; said in fewer words, their current level of cash generation
significantly exceeds their ability to deploy it intelligently. Looking at the companys
business holistically, as well as compared to the level of cash required to run the business
historically, one could easily argue that $50 billion or more of cash on the books is not
needed, and will not be used, for the foreseeable future (thats different than a company like
Berkshire Hathaway (BRK.A)(BRK.B), where investors can be confident that funds will be
intelligently put to use at some point down the road even if they dont know exactly when
that will be). From my perspective, theres a cost to holding those funds: While Microsofts
management team might not find a way to intelligently deploy that roughly $6 per share in
excess cash (and from my perspective has little to no possibility of doing so), I think I could.
For these companies, thats a real point of consideration for the equity investor.
So now that Ive rejected the two conventions from above, where should we go? I believe a
logical approach, based on those arguments, would call for somewhere in between:
penalizing companies for the expected taxes to be paid and the time value of money (with
the second component clearly being pretty subjective), while simultaneously recognizing
that having billions in excess cash is likely to be a good thing even if we cant pinpoint
when that will be.
The second component will require some study of the companys previous capital
allocation decisions from repurchase timing (as Ive discussed with Deere, here) to the
use of M&A (how much did the $11 billion spent on Autonomy prove to be worth to Hewlett-
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Packard (HPQ) investors?), as well as the impact of outsiders or insiders (new
management and board members); in the case of Microsoft, I think that final point is
particularly important at this point in time (Im confident that ValueAct will push for action).
You might be thinking that Ive weaseled my way out of an answer: in the case of Microsoft,
Ive left you somewhere between $0 and $100 billion quite a bit of space (to say the
least!) and a conclusion youve likely come to on your own. For one key reason, I think thats
just fine: Putting a specific number on the value of the excess cash is pretty futile in almost
all situations. Even in these cases, where the cash on hand is a large percentage of the
market capitalization, how important is nailing the real value of Microsofts cash? If you
settle on $60 billion and I settle on $50 billion, does that really address the big questions in
valuing the stock? If youre an investor that buys with a margin of safety of 30% or more, the
difference is peanuts.
But that gets to a bigger point: Youre doing yourself a disservice if you pigeonhole the
concept of intrinsic value into a P/E ratio (or EV/EBITDA, etc.); investors take false
comfort in a world of comparable (to a companys peers and the market as a whole) and
historical multiples.
The reality is that valuing a company or the cash on its books requires thorough and
thoughtful analysis; it cant be simplified into a formula or rule of thumb. Depending on your
perspective, and your willingness to devote time and energy to analysis, I think that can be
a real blessing a way to differentiate from the herd with justified confidence.
Something as simple as counting the cash on the balance sheet can be a step in that
direction.
About the author:
The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering
from short term issues, and hope to load up when these opportunities present themselves.
As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-
10 names; from the perspective of a businessman rather than a market participant / stock
trader, I believe this is more than sufficient diversification.
I hope to own a collection of great businesses; to ever sell one, I would demand a substantial
premium to the average market valuation due to what I believe are the understated benefits to
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Aagold - 5 days ago
Science,
You seem to have forgotten about debt in your calculations. It's clearly incorrect to
calculate an earnings multiple excluding cash while ignoring debt, otherwise
companies could give themselves an arbitrarily low earnings multiple simply by
issuing debt and putting the cash raised into their bank account. At most you can
back out the *net* cash (i.e., cash - total debt) when calculating an earnings
multiple.
- aagold
The Science of Hitting - 5 days ago
Aagold - Good point; I purposely avoided that part of the conversation for this
article, but it certainly should be considered by the investor in their analysis.
Thanks for the comment!
Snowballbuilder - 4 days ago
Science ! your articles are usually the first I read on gurufocus
and that is another great one on a central point !
4 of my 6 holding are NET cash positive so I really value cash a lot !
as Berkowitz said "at the end of the day cash is all you can spend"
and is also more difficult to make up cash in bank and free cash flow that gaap
earning
Comments
the long term investor of superior fundamentals and time on intrinsic value. I don't have a
target when I purchase a stock; my goal is to replicate the underlying returns of the business
in question - which if I've done my job properly, should be very attractive over many years.
Rating: 4.6/5 (11
votes)
Voters:
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I really appreciate a company that have little or no debt, a lot of cash and every
year make a lot of free cash available for dividend , buyback , buildup or M&A.
But how I value that company ?
when I calculate roe and roce I DONT consider the net cash (so I use ROE and
ROCE at cash=0)
and also when I check the classic multiples (P/E , P/ FCF, EV/EBIT) I dont
consider the net cash.
I simply take the net cash (and net cash / shares) number in my mind . Like an
extra margin of safety and a signal that the company is able to make real free
money .
As I said at the beginning I value cash a lot so if a company with a simple business
model and a strong competitive position has
high ROE , low P/E, and a lot of NET cash on balance sheet is a candidate to
become my 7 holding
take care and happy investments . snowballbuilder
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