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Counting Dollar Bills

The Science of Hitting

The Science of Hitting

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In corporate America, cash is king: Moody’s 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, here’s 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 I’m not sure that the second 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 I’ll use as an example because it’s 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 company’s 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 (that’s 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 don’t know exactly when that will be). From my perspective, there’s a cost to holding those funds: While Microsoft’s 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, that’s a real point of consideration for the equity investor.

So now that I’ve 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 can’t pinpoint when that will be.

The second component will require some study of the company’s previous capital allocation decisions — from repurchase timing (as I’ve 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-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 (I’m confident that ValueAct will push for action).

You might be thinking that I’ve weaseled my way out of an answer: in the case of Microsoft, I’ve left you somewhere between $0 and $100 billion — quite a bit of space (to say the least!) and a conclusion you’ve likely come to on your own. For one key reason, I think that’s 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 Microsoft’s 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 you’re an investor that buys with a margin of safety of 30% or more, the difference is peanuts.

But that gets to a bigger point: You’re 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 company’s 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 can’t 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 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:

Comments

aagold
Aagold premium member - 4 months 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
The Science of Hitting premium member - 4 months 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
Snowballbuilder - 4 months 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

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

The Science of Hitting
The Science of Hitting premium member - 4 months ago

Snowballbuilder: Sorry for the delayed response - and that's a great point. I think this especailly important when looking at ROA, ROE, ROIC, etc, as you noted; as with many things in investing, there's a bit of nuance here when analyzing the numbers (as reported) that should not be overlooked. Thanks for the comment!

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