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Finance 101: Being cash-rich is a major advantage in environments where fundraising is a major hurdle, and where the funds can be put to productive use very qui

by noego 7y ago

Finance 101: Being cash-rich is a major advantage in environments where fundraising is a major hurdle, and where the funds can be put to productive use very quickly. For example, for a startup to raise funds for a major marketing campaign, it has to go through a lengthy and attention-demanding process of pitching to VCs and negotiating terms. Hence why having a big war-chest ready to fire, can be a competitive advantage for a startup. For big public companies, it's the opposite. If a company wants to fundraise 10% of its market-cap, either for an acquisition or major investment, it doesn't require nearly as much effort. It can issue new shares, and immediately sell them to investors the next day for cash. The hard part is finding profitable investments, not raising the funds to make it happen. Hence why there's little competitive advantage in hoarding cash. On the flip side, having a big cash hoard is bad for your investors' returns. It bloats your market-cap, without having any impact on earnings. This means that your P/E ratio is now inflated, and your earnings yield is reduced. From an investor's perspective, if you have invested $100 in the company, you're only only getting back $6 in profits every year, not $7 or $8. Another way to look at this, is that Google/Apple invest their cash hoard very conservatively, in things like short-term treasuries, because of which their returns are very low. Whereas most of their investors would far prefer to invest the money in investments that produce better returns, such as the S&P 500. By not returning the cash hoard to its investors, Google is essentially forcing them to make low-return investments that they would never make otherwise. Of course, investors aren't going to be happy with this, and they will retaliate by lowering their valuation of GOOG stock, thus depressing the share price.

LeifCarrotson 7y ago
> Whereas most of their investors would far prefer to invest the money in investments that produce better returns, such as the S&P 500. Curiously, GOOG and AAPL are two of the many large companies who have large cash hoards who are themselves part of the S&P 500.
mercules 7y ago
At the same time, companies with a strong warchest are better prepared to weather the storm of an economic downturn and to afterwards, purchase valuable assets for pennies on the dollar.
- gvhst 7y ago
  Buffett puts this well when he says: > “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.” The thing here is you have to be confident in your ability to deploy capital during those downturns. Your average expected return over multiple cycles (cash returns mid/late cycle + opportunistic investments beginning of cycle) needs to be higher than broad equity returns.
  - mastratton3 7y ago
    ^This.. I don't see why people thinking hoarding cash when capital is cheap is a bad strategy. It totally ignores the fact that ease of raising and cost of capital is time dependent. If you had a war chest of cash in 2008/2009, that'd be insanely valuable.
    - ptr 7y ago
      On the other hand, that's timing the market. But as the common wisdom goes, time in market pays better. Or does it? Do these companies know something that we don't? Is it different when you have piles of money?
matthewvincent 7y ago
Apple has spent ~30 billion on share buybacks this year so, I’d say pretty shareholder friendly.
jjeaff 7y ago
Ya, that's finance 101. But here's Finance 5400: Smart, wealthy shareholders love cash hoarding. Especially if the cash is held tax free in overseas accounts. The share price is boosted allowing them to get returns in the form of pure capital gains. If the company were to pay dividends, sure, most of those dividends would be taxed at capital gains rates as well. But that money has to be taxed at the highest US corporate income tax rate first. Thus, significantly reducing overall value. To go a step further, the wealthy don't even have to cash out their shares as the price climbs and climbs. They can get low interest loans using the shares as collateral. This deferring taxes indefinitely and leaving all their capital in these huge companies that are outperforming the SP500 anyway.
- olde_fortran 7y ago
  Dividends at taxed at income tax rates
  - sureshv 7y ago
    They are taxed as capital gains for recipients. Edit: *qualified dividends
    - nickles 7y ago
      > They are taxed as capital gains for recipients. No, ordinary dividends are taxed as income.
  - _delirium 7y ago
    True for ordinary dividends, but almost all stock dividends meet the criteria to be treated as qualified dividends, taxed at capital gain rates. For example, in Vanguard's S&P 500 index fund, about 98% of dividends are qualified [1]. Of commonly traded classes of stocks, only real-estate funds mostly pay out ordinary dividends. [1] https://advisors.vanguard.com/VGApp/iip/advisor/csa/investments/taxcenter/yeartodate https://advisors.vanguard.com/VGApp/iip/advisor/csa/investme...
    - 7y ago
nootka 7y ago
How does cash raise market cap aside from maybe causing uninformed investors to drive the price up? Isn't market cap share price * shares outstanding? Hence, capitalization in the market, rather than capital available internally.
- Expez 7y ago
  Imagine a company has 100 shares and for argument's sake let's assume that company is never going to turn a profit but break even forever. What would you pay for one of those shares? Nothing, right? The company is worthless. Now imagine that same company has a bank balance of $100. Each share now also owns a 1% share of the bank balance (because it owns 1% of the company itself). How much would you pay for such a share? Anything below a dollar seems pretty good to me! In other words, the more valuable assets the company holds, the more we'd be willing to pay for shares of the company, all else equal. This is called the 'book value' of a company and is total assets - intangible assets (patents, goodwill) and liabilities. Note that the real-life situation is slightly more complex because you can't always get at the assets, even if you buy the shares for cents on the dollar. But the general idea is that you can buy shares until you have enough voting rights to dole out the cash as dividends.
- tasuki 7y ago
  Yes market cap is share price * shares outstanding. The shares that are bought-back are destroyed, lowering the number of shares outstanding, increasing the per-share price.
aresant 7y ago
“Google/Apple invest their cash hoard very conservatively, in things like short-term treasuries, because of which their returns are very low” This is actually wrong. Apple alone wholly owns one of the world’s largest investment funds - Braeburn Capital - that actively manages over $270b of Apples assets leveraging very sophisticated investment strategies. The extent to which managing its cash is now a value-add part of Apple’s business is well outlined in the tongue-in-cheek article from WSJ “Apple Is a Hedge Fund That Makes Phones” https://www.google.com/amp/s/www.wsj.com/amp/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375 https://www.google.com/amp/s/www.wsj.com/amp/articles/apple-...
- earenndil 7y ago
  Non-AMP url: https://www.wsj.com/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375 https://www.wsj.com/articles/apple-is-a-hedge-fund-that-make...
  - myroon5 7y ago
    Non-AMP Non-paywalled URL: https://www.wsj.com/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375?mod=rsswn https://www.wsj.com/articles/apple-is-a-hedge-fund-that-make...
ajross 7y ago
> On the flip side, having a big cash hoard is bad for your investors' returns. This is absolutely true, but sort of misses the point. What happens in practice is that such stocks end up being disfavored and investors prefer to buy other securities with better dividends. Which has the effect of depressing the share price. Which has the effect of making it harder for the company to raise money via issuing debt or stock. ...which the company doesn't care about in the first place, because it's sitting on a truck load of cash and doesn't need to raise money. Honestly, the jury is very much out on whether or not this kind of behavior is bad for companies in a micro sense. Really all it means in practice is that these companies haven't been able to find a way to invest this money productively, they're out of ideas to purse, or markets to expand into. And that's bad, but it's not bad because of cash. In a macro sense, though, the argument is clearer: all that money sitting around doing nothing (well, nothing but sitting around in safe investments) does nothing for the GDP as a whole, and in particular it does nothing for the bulk of the population with little to no investment holdings.

by noego 7y ago

LeifCarrotson 7y ago

> Whereas most of their investors would far prefer to invest the money in investments that produce better returns, such as the S&P 500. Curiously, GOOG and AAPL are two of the many large companies who have large cash hoards who are themselves part of the S&P 500.

mercules 7y ago

At the same time, companies with a strong warchest are better prepared to weather the storm of an economic downturn and to afterwards, purchase valuable assets for pennies on the dollar.

gvhst 7y ago
Buffett puts this well when he says: > “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it's imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.” The thing here is you have to be confident in your ability to deploy capital during those downturns. Your average expected return over multiple cycles (cash returns mid/late cycle + opportunistic investments beginning of cycle) needs to be higher than broad equity returns.
- mastratton3 7y ago
  ^This.. I don't see why people thinking hoarding cash when capital is cheap is a bad strategy. It totally ignores the fact that ease of raising and cost of capital is time dependent. If you had a war chest of cash in 2008/2009, that'd be insanely valuable.
  - ptr 7y ago
    On the other hand, that's timing the market. But as the common wisdom goes, time in market pays better. Or does it? Do these companies know something that we don't? Is it different when you have piles of money?

matthewvincent 7y ago

Apple has spent ~30 billion on share buybacks this year so, I’d say pretty shareholder friendly.

jjeaff 7y ago

Ya, that's finance 101. But here's Finance 5400: Smart, wealthy shareholders love cash hoarding. Especially if the cash is held tax free in overseas accounts. The share price is boosted allowing them to get returns in the form of pure capital gains. If the company were to pay dividends, sure, most of those dividends would be taxed at capital gains rates as well. But that money has to be taxed at the highest US corporate income tax rate first. Thus, significantly reducing overall value. To go a step further, the wealthy don't even have to cash out their shares as the price climbs and climbs. They can get low interest loans using the shares as collateral. This deferring taxes indefinitely and leaving all their capital in these huge companies that are outperforming the SP500 anyway.

olde_fortran 7y ago
Dividends at taxed at income tax rates
- sureshv 7y ago
  They are taxed as capital gains for recipients. Edit: *qualified dividends
  - nickles 7y ago
    > They are taxed as capital gains for recipients. No, ordinary dividends are taxed as income.
- _delirium 7y ago
  True for ordinary dividends, but almost all stock dividends meet the criteria to be treated as qualified dividends, taxed at capital gain rates. For example, in Vanguard's S&P 500 index fund, about 98% of dividends are qualified [1]. Of commonly traded classes of stocks, only real-estate funds mostly pay out ordinary dividends. [1] https://advisors.vanguard.com/VGApp/iip/advisor/csa/investments/taxcenter/yeartodate https://advisors.vanguard.com/VGApp/iip/advisor/csa/investme...
  - 7y ago

nootka 7y ago

How does cash raise market cap aside from maybe causing uninformed investors to drive the price up? Isn't market cap share price * shares outstanding? Hence, capitalization in the market, rather than capital available internally.

Expez 7y ago
Imagine a company has 100 shares and for argument's sake let's assume that company is never going to turn a profit but break even forever. What would you pay for one of those shares? Nothing, right? The company is worthless. Now imagine that same company has a bank balance of $100. Each share now also owns a 1% share of the bank balance (because it owns 1% of the company itself). How much would you pay for such a share? Anything below a dollar seems pretty good to me! In other words, the more valuable assets the company holds, the more we'd be willing to pay for shares of the company, all else equal. This is called the 'book value' of a company and is total assets - intangible assets (patents, goodwill) and liabilities. Note that the real-life situation is slightly more complex because you can't always get at the assets, even if you buy the shares for cents on the dollar. But the general idea is that you can buy shares until you have enough voting rights to dole out the cash as dividends.
tasuki 7y ago
Yes market cap is share price * shares outstanding. The shares that are bought-back are destroyed, lowering the number of shares outstanding, increasing the per-share price.

aresant 7y ago

“Google/Apple invest their cash hoard very conservatively, in things like short-term treasuries, because of which their returns are very low” This is actually wrong. Apple alone wholly owns one of the world’s largest investment funds - Braeburn Capital - that actively manages over $270b of Apples assets leveraging very sophisticated investment strategies. The extent to which managing its cash is now a value-add part of Apple’s business is well outlined in the tongue-in-cheek article from WSJ “Apple Is a Hedge Fund That Makes Phones” https://www.google.com/amp/s/www.wsj.com/amp/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375 https://www.google.com/amp/s/www.wsj.com/amp/articles/apple-...

earenndil 7y ago
Non-AMP url: https://www.wsj.com/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375 https://www.wsj.com/articles/apple-is-a-hedge-fund-that-make...
- myroon5 7y ago
  Non-AMP Non-paywalled URL: https://www.wsj.com/articles/apple-is-a-hedge-fund-that-makes-phones-1535063375?mod=rsswn https://www.wsj.com/articles/apple-is-a-hedge-fund-that-make...

ajross 7y ago

> On the flip side, having a big cash hoard is bad for your investors' returns. This is absolutely true, but sort of misses the point. What happens in practice is that such stocks end up being disfavored and investors prefer to buy other securities with better dividends. Which has the effect of depressing the share price. Which has the effect of making it harder for the company to raise money via issuing debt or stock. ...which the company doesn't care about in the first place, because it's sitting on a truck load of cash and doesn't need to raise money. Honestly, the jury is very much out on whether or not this kind of behavior is bad for companies in a micro sense. Really all it means in practice is that these companies haven't been able to find a way to invest this money productively, they're out of ideas to purse, or markets to expand into. And that's bad, but it's not bad because of cash. In a macro sense, though, the argument is clearer: all that money sitting around doing nothing (well, nothing but sitting around in safe investments) does nothing for the GDP as a whole, and in particular it does nothing for the bulk of the population with little to no investment holdings.