Accounting for Cash?

[Kerim]

So I was chatting with a friend (in the real world!) about how to factor a company's cash pile when assessing the share price and P/E ratio.

I assume there are several ways to approach the question mathematically (or pseudo-mathematically). The simplest that comes to mind for me is to subtract the per-share cash amount from the per-share price before dividing by earnings. For example, if the share price is $100, and earning are $5 per share, you've got a P/E of 20. But if the company is sitting on, say, $10 per share (total cash pile divided by shares outstanding), then it might be fair to think of the P/E as closer to 18 instead of 20 ($90 divided by $5).

Of course this kind of assumes that that the company were to pay out the entire cash pile as a special dividend to existing shareholders. They might use it instead to grow the business, make acquisitions, pay down debt, pursue buybacks, buy shares of other companies, etc.  

How do you all think about the cask piles many companies are hoarding right now? How do you factor them into your analysis and decision-making? Any links to relevant information?

Thanks!

[fenders53]

Cash is downstream of net income or earnings. It would affect my opinion of the overall value of the company as an investor, (much like debt or the lack there of), but not relevant to the PE IMO. A company might own 90% of their buildings and capital equipment, or perhaps only 10%. The PE would become meaningless if you adjust it into a stat it is not intended to represent.

[Kerim]

Well, yeah, sure. But that doesn't make it a meaningless exercise. I'm not suggesting it is a better or different way of calculating the "P/E." I'd be happy to call it a "Cash-Adjusted P/E" or something. And everyone can decide whether it should carry any weight at all or if it is completely nonsensical (for reasons I'd like to understand). I'm sure it isn't an original thought; I'll try to find time for some googling.

EDIT: YCharts, for what it's worth, seems to think it is a thing.

Further EDIT: The more I look at that link, the less I understand it. The text description sorta sounds like what I proposed above, but it also suggests -- and the "formula" indicates that they are subtracting cash per share from earnings per share. That sounds super bizarre to me and truly is commingling apples and oranges. And very different from what I meant. I'm tempted to wonder if it isn't an error, but even my ego isn't that big...

[fenders53]

I'm no accountant but it does seem like comingling. Cash has importance of course and is part of other important financial ratios, reports, credit rating etc.

[rayray]

hmmmm....when i read the title i thought this was in reference to dry powder lol

i check several web sites and will read analyst/company opinions/reports

other then that i don't reconfigure the numbers to my own analysis--if i did that i'd own 10/12 stocks

[fenders53]

It's actually a topic we don't discuss enough. Select companies are hoarding cash but I actually think it's a minority. Those that can hoard may be doing it for many different reasons. If the FANG stocks aggressively engage their cash they will draw the ire of regulators for squelching competition. JNJ cash is a target for thousands of lawsuits. Berkshire cash was an attempt to time the market and buy low. Something that worked for Buffett for decades but has cost shareholders when the crash is already 3 years late. He completely missed the bus in 2020 and left 50% gains from that money on the table. He may redeem himself next year if he can pick up some assets 30% off. Time will tell.

It's that recency bias thing again. Bottom line is cash is currently a drag on returns with 0% interest and booming GDP growth. If the FED were to raise rates to 2% the cash would matter, but the markets probably just corrected 30%+ so an investor isn't ahead in the short-term. I'll direct my concerns to companies with excessive debt that have no ability to pay it down in less than favorable market and economic conditions.

On a side note politicians are coming after some of this cash soon in the form of taxes. They'll probably get some if it to partially pay for stimulus. Stimulus caused the recent cash bounty so I guess it balances out in the end.