Recently, there was talk about how Apple (AAPL) finished the year with more than $97 billion in cash and short-term and long-term investments; and there was some fun speculation regarding what Apple can buy with its $97 billion. However, Apple doesn't have $97 billion dollars in extra cash. Some of the $97 billion is needed or desired on the balance sheet.
The best question to ask is not: "How much cash does the company have?" The best question to ask is: "How much cash excess or scarcity does the company have?"
Three Reasons Why Companies Need or Want Cash on Hand
1. Regular Business Activity
The amount of payments received on a given day almost never matches the amount of payments due on that same day. You don't want to have to hold off on paying suppliers, workers, et cetera because not enough payments were received recently. It is inefficient, and it is bad for supplier, worker, et cetera relations.
2. Rainy Day Protection
What if a key factory or stores are struck by a natural disaster and you do not have business continuation insurance? What if a court orders you to stop selling a product due to a patent issue? What if the market for your products takes a relatively sudden, strong downturn? You may not be able to think of anything that could go wrong for which you would need cash available; but, if you can, it is best to accommodate some for possibilities that you can't think of.
3. War Chest Purposes
It is good to be able to acquire other businesses, or aspects thereof, in cash. Also, you may decide to increase your capital expenditures in the future.
Based upon data gathered from Zacks, Finviz and MSN Money at the end of February, the average S&P 500 company appears to have 56.17% of one quarter's sales minus earnings (without non-recurring income) in cash and short-term investments. Subtracting earnings from sales is a practical way to estimate total costs and expenses, so the average S&P 500 (SPY) company appears to have about 56.17% of one quarter's total costs and expenses worth of cash on hand.
Calculating the Cash That Apple Should Have on Hand to Be Like Its S&P 500 Peers
Increase in cash and cash equivalents last quarter: $495 million
Purchases of marketable securities last quarter: $40,175 million
Proceeds from marketable securities last quarter: ($24,510 million)
Increase in cash and short/long-term investments: $16,160 million (Sum of the above 3 items)
Net sales last quarter: $46,333 million
One quarter's total costs and expenses: $30,173 million (Above sales minus above cash/investments increase)
56.17% of one quarter's total costs and expenses: $16,948 million
Calculating Apple's Relative Cash Excess
Cash, cash equivalents and short/long term investments: $97,601 million
56.17% of one quarter's total costs and expenses: $16,948 million
Cash Excess (+) or Scarcity (-) $: +$80,653 million (Cash and short/long term investments minus 56.17% of 1 Q's costs and expenses)
Cash Excess (+) or Scarcity (-) %: +476% (Cash Excess or Scarcity $ divided by 56.17% of 1 Q's costs and expenses)
The 56.17% figure is a rule of thumb that can be used for S&P 500 companies. Sometimes this rule of thumb is not the best one to use though. For instance, your stock may not be in the S&P 500; and the utilities companies in the S&P 500 keep far less cash on their balance sheets, and you may want to compare utility companies to each other. The need and desire for cash can vary a lot by country, industry or company.
Factors Affecting How Much Cash a Company Should Seek to Keep on Hand
1. Company Size
Generally, bigger companies have a lesser need to keep cash on hand (on a percentage basis) because, for instance, they are more likely to get a loan in a pinch.
2. Debt Level
It's easier to borrow if you have little or no debt. It's harder to borrow if you have a lot of debt.
3. Importance to Society
More important companies, like utilities, have a lesser need to keep cash on hand because, for instance, they are more likely to get government or other assistance in a pinch.
4. Revenue Diversification
The greater your geographic reach and the variety of your products or services is, the less cash you need to keep on hand. Diversity lends stability to your revenue stream.
5. Revenue Dependability
Some revenue streams are more dependable than others. For example, if you sell non-luxury food items, your income stream is rather dependable because people need to eat; and, if you sell fad items, your revenue stream is less dependable.
Your total costs and expenses may be much greater during the 4th quarter (leading up to and during the holidays) or during the summer months, if you are an agricultural or vacation company. If there is significant seasonality, it is best to determine a company's cash needs based upon its most challenging quarter.
How does Apple score on the above criteria?
Apple is about the 14th-largest company in the S&P 500 by annual sales, so we can give it a 1 on a scale of 1 to 5 for Company Size. Apple has no debt, so we can give it a 1 for Debt Level. If Apple fails, society will be O.K. If the U.S.-headquartered high-end electronics industry as a whole struggles enough, it may get government or other assistance; so we can give Apple a 4 for Importance to Society (in this context). Apple has strong geographic diversification, but rather weak product diversification. It has a limited product suite, and over ½ of its revenue last quarter was iPhone-related; so we can give it a 4 for Revenue Diversification. We like Apple products a lot, but we don't need them much. We don't need an iPod, and almost all of us can make do with a less expensive mobile phone or personal computer. Apple has plenty of competition, but its customers are definitely more loyal than is usual; so we can give it a 4 for Revenue Dependability.
All told, Apple seems to have about average cash needs; but this is compared with a typical company. The companies in the S&P 500 tend to have lesser cash needs.
Apple's peers in the S&P 500 technology sector have much more cash on hand than the average S&P 500 company.
|S&P 500 Sector||Number of Companies||Cash / 1 Quarter's Estimated Costs & Expenses|
Apple's Cash Excess Statistics Using the S&P 500 Technology Sector Standard
Cash Excess $: $49,792 million
Cash Excess %: 104%
Cash Excess Per Share: $53.41
Cash Excess Adjusted P/E Ratio (ChEAPER): 11.18 (Using this financial year's estimated EPS and the March 5 closing share price)
(If your company has a Cash Scarcity, you can calculate its Cash Scarcity Adjusted P/E Ratio [ChSAPER].)
Unadjusted P/E Ratio: 12.42
This indicates that, as of the end of last quarter, Apple could have paid a special dividend of $53.41 and still be in line with its S&P 500 technology sector peers in terms of cash. This dividend is equivalent to 10% of the company's closing share price on March 5.
If you are wondering how a company with rather strong earnings growth and a strong reputation can trade at a relatively low P/E ratio, consider that, although Apple's cash needs seem to be about average, its earnings profile appears to be risky. Its low product diversity, low revenue dependability, and relatively high net income margin (28% in the last quarter) make its earnings significantly riskier than is the norm.
How does your stock measure up? What cash standard is best applied to it, and does it have a Cash Excess or a Cash Scarcity?