How do you value Cash!!!!
Being a price driven investor/Trader, I spend an awful lot of time with value investors.
I don’t see any dichotomy with this at all. As they say, you should always be on a lookout for dis-confirming evidence ;)
Jokes apart, here is an interesting thing i noticed and decided to pen down my thoughts.
While valuing a company, What do you do with the cash component. The Pile that company has accumulated over the years through its competitive advantage.
Its presence tells you that something is going right in the company. They are able to generate cash and accumulate it. A company needs a good level of cash to operate smoothly and its presence tell you that management will not be diluting itself in near future.
BUT where I disagree is when analysts/investors take that pile into consideration when valuing a company!!!!!
I don’t agree with that at all.
I reserve the right to be wrong, as i feel Stock market is a discounting machine. The cash pile of the company is ITS PAST and therefore already priced in.
It simply tells me 02 things, A) company has done well in the past and B) it does not have any growth avenues available. And as we know a good company is one which has the ability to deploy incremental capital at same or higher rates of return.
The very fact that company is sitting with a big pile tells me that the said company is in Relaxed phase of its life, Picture a fat middle aged comfortable uncle with a belly.
(Ofcourse on a side note, I must add that it is a much better state to be in compared to expanding for expansion’s sake. That is sheer disaster).
Either it doesn't have the drive or it is in an industry where there is No growth or it is already too big compared to the size of the industry, either ways not a place to look if you are young and interested in getting rich within your timelines.
Analysts derive the future price of the company based on a multiple of revenue, sales, earnings or cash flow. The more savvy ones try to derive owner’s earnings Vs plain vanilla earnings.
And then after that they simply add the cash balance to the price target (sometimes with a discount if they ‘feel’ that management is not great)
reminds me of a joke where a stand-up comedian asked the audience to rank themselves on a score of 0 to 10 as to how much they think they have been loyal to their spouses. After the scoring, he says, “ barring people who gave themselves a 0 or a 10, all of you others are douche bags.
Integrity doesn’t come in scales. You are either loyal or you are not ;)
anyways without digressing lets continue…
As i have seen (back test needed to confirm) huge cash piles act as a BIG DRAG on stock price performance. Markets Punish companies with huge cash piles and rightly so (Inability to reinvest). Surely, once in a while it gets it wrong and throws baby with the bath water (Piramal enterprises) but 8 out 10 times it gets it spot on (RSSoftware)
Novice value investors make rudimentary error by screening for companies with cash. That route takes them directly to value traps.
Remember, as a Momentum investor, i am interested in seeing GROWTH. That decides the future trajectory of a stock. Cash pile is just past info, means nothing.
Comments are welcome.