Recently, a number of value investors have noted that large cap stocks appear rather cheap by historical standards. The P/E ratio is one of the most useful metrics for determining how cheaply a company may be purchased. But as we've discussed before, it cannot simply be applied blindly; company earnings may be temporarily depressed, or may be high due to one-time gains. But even if earnings are corrected or smoothed to reflect fluctuations in the business cycle, a company's balance sheet position may be so exceptional that it also has a material effect on a company's would-be P/E.
Consider some of the strongest cash generating businesses in the world: Apple (AAPL), Google (GOOG), Microsoft (MSFT) and Research in Motion (RIMM). Their P/E's are not that high considering the returns on capital that they generate. Furthermore, their P/E's are lower than they appear at first glance, as after adjusting for their cash balances, these companies appear even cheaper. The chart below illustrates this, by showing these four companies (along with cash-rich KSW (KSW), a company we have discussed as a potential value investment) with their P/E's after adjusting for their cash balances:
Disclosure: Author has a long position in shares of KSW.