So the 1% has all the money . . . help me make the point based on investor filings.

October 3, 2011 2:34 PM

[financial analysis filter] How can I identify the amount of money that a publicly-traded company could spend without being irresponsible to its investors or its ability to continue operating?

I'm working on a project where we would like to argue that big publicly-traded firms are sitting on a bunch of cash and should be investing it in the economy, their employees, the working class, you get the picture. My questions is this: using the information these public companies disclose to the SEC and their investors, how should I identify whether this is a strong/valid argument?

To give you an idea of what I mean:

I was planning to use an analysis of the company's current ratio (assets/liabilities=current ratio): Let's say the average current ratio in the warehousing industry is 1.2, and the Kensington314 Warehouse Company has a current ratio of 1.5. In the simplistic view I've taken of the current ratio analysis, the company is idly sitting on however much money it would take to bring their assets-to-liabilities ratio down to the industry standard of 1.2.

Is that too simplistic? Inaccurate? Is there a better measure that firms use to know how much money they could invest or spend without going under?

posted by kensington314 to work & money (16 answers total)

Is there a better measure that firms use to know how much money they could invest or spend without going under?

That is the job of the executive management team of the company in question. You certainly can do external analysis, but you should know the history of what you propose before you run around trying to "improve" someone else's business.

In the late '70s and through the '80s, your question was a very popular one: which companies are sitting on excess assets that could be stripped out and sold for fun and profit? The result was a lot of profit for junk bond traders and corporate raiders (fictionalized in the film Wall Street). That you want to do the same thing but spend the money differently doesn't really change things.
posted by b1tr0t at 2:46 PM on October 3, 2011 [1 favorite]

I'm not sure regulatory filings or investor communications are the way to go. Before collecting and validating data, what you first have to do is have a hypothesis that holds up, and I'm not sure you do. There are a large number of reasons why companies sit on cash: long-term debt, anticipated future acquisitions, anticipated need to fight off a future acquisition attempt, the ability to survive a downturn in the market.

The past decade has been a great example of the last issue. Companies with cash were able to make it through the downturn in far better shape than companies that didn't have cash to spend. They did what people should do: They saved for a rainy day. And in the end, they made it through the storm. And by surviving, they were able to pay taxes, provide business to suppliers, and employ people. By paying taxes, they helped fund the government, which has been providing social services. By providing business to suppliers, they've been able to enable other companies to do the same. Both of those companies have been employing people the whole time, which provides income, provides tax revenue, enables consumption, and so on.

It isn't that your argument is simplistic or inaccurate, but just that it focuses only on an immediate short term issue, when the company has to think long term to provide for itself and for the people it employes (the "working" class). When companies start to focus on the short term rather than the long term, very bad things happen...
posted by NotMyselfRightNow at 2:57 PM on October 3, 2011

it will depend on the variability of cashflows. Just looking at todays balance sheet to make that decision is a very bad methodology. ROE's and margins are historic highs, then will mean revert and cashflows will mean revert, probably undershooting the mean for a period of time. You need to see what future scenario the company is prepared for and if that's really realistic, and then see how much cash/liqudity they need for that and what's left over could reasonably be called excess capital.

An alternate approach is to look at the marginal return on capital for the business and use that to make an argument for increasing remuneration to labor.

You also need to take into account the return on capital on the money they can put back into the firm. If they can't reinvest in the business, then their options are to return capital to shareholders or other stakeholders. But the board can't screw the shareholders too much or they'll get fired.

(Basically this is really fucking hard what you are trying to do, if you want to do it well.)
posted by JPD at 2:58 PM on October 3, 2011

It's too simplistic because you presume that the industry "standard" (I think you mean average) is the optimal level of cash for a given company. That doesn't follow.
posted by dfriedman at 3:10 PM on October 3, 2011

No one ratio will work alone. For example, the current ratio isn't going to tell you how much capital spending a company will need in order to remain competitive.

This is going to be a difficult task that involves a lot of assumptions and will be difficult to standardize over industries. And what is your time frame? The maximum dollars that a firm could possibly spend right at this moment is unlikely to be the same as what that firm should spend to maximize economic value.

But, for the sake of it, you could do an LBO-like free cash flow analysis over the course of a year:

Net income + non-cash items (depreciation & amortization) - change in working capital - maintenance capital expenditures = free cash flow + cash on the balance sheet - amount of principal debt due during the year = cash available for distribution. That number could theoretically be re-invested in the business (or used to pay dividends, buy back shares, pay down debt, hoard on the balance sheet, etc).

You could really juice that number by adding on the amount of money a company could borrow, assuming it's balance sheet is currently underlevered.

But none of this is going to tell you how much a company ought to be spending. That will require the kind of nuanced analysis that JPD describes.
posted by mullacc at 3:12 PM on October 3, 2011

There's no reason why cash on a company's balance sheet ought to do anything else than sit there. This is business, and unfortunately, there isn't any sort of moral 'ought' to be applied. Companies must follow laws and regulations.

Profitable companies generate cash. The cash can sit in the bank, be invested in securities, be paid out as dividends, used to buy back shares, or buy other companies. The management of the company gets to decide what happens with this cash.

The biggest reason companies are sitting on as much cash as they are is because they are not suppy constrained. For the most part, companies can use existing equipment, inventory and personnel to supply all the goods being demanded. They don't need to invest to meet existing demand.

There isn't some sort of nefarious reason why they're sitting on cash right now. There's uncertainty about the economic fundamentals, so they're averse to raising dividends, which are relatively low, and they aren't supply constrained.

Here's the Capacity Utilization graph for the last few decades.
posted by thenormshow at 3:44 PM on October 3, 2011

Thanks to everyone so far. These answers so far are all super-useful in helping me sort through this stuff.

I think it might be useful for me to clarify that I'm not assuming any kind of ill intention. I'm assuming some combination of regulation, good business practices, bad business practices, rainy-day planning, and general restrained recession thinking makes up for whatever overly-conservative amount of cash one might judge a company to have.

I know at the same time that the one ratio I've cited, the common ratio, is sometimes used by investors and others to judge whether a company is being overly conservative or not conservative enough in its dealings, which is why I started there. But I also know that's not the end all be all of financial analysis.

I was hesitant to post because my understanding of this stuff is rather pedestrian to begin with, and I don't want to sound like I'm just looking for hacky solutions that fit a pre-determined argument. I also gather that these types of analyses are not watertight, and they depend on company, industry, geography, and all kinds of individual circumstances for each company.

Keep 'em comin'. Thanks again.
posted by kensington314 at 4:07 PM on October 3, 2011

I know at the same time that the one ratio I've cited, the common ratio, is sometimes used by investors and others to judge whether a company is being overly conservative or not conservative enough in its dealings, which is why I started there. But I also know that's not the end all be all of financial analysis.

It is one thing for a few retail customers to use a rule of thumb to guide their investing. In a few quarters, they will be proved right or wrong. It is an entirely other thing to base a regulatory scheme around the same kind of metric.

I was hesitant to post because my understanding of this stuff is rather pedestrian to begin with, [...]

It is fine to ask questions, how else are you going to learn?

[...] and I don't want to sound like I'm just looking for hacky solutions that fit a pre-determined argument.

If you don't want to sound like you are looking for hacky solutions that fit a pre-determined argument, you shouldn't open with something like "I'm working on a project where we would like to argue that big publicly-traded firms are sitting on a bunch of cash and should be investing it in [...]" Because that is pretty much the definition of looking for hacky solutions that fit a pre-determined argument.

It is cool to have an agenda, just be aware that your regulatory hackery could very well backfire and hurt the very people you want to help. But if you make this a research project and publish your findings, you can both add to the general understanding of corporate finance and warn other people away from dangerous strategies. In order to do that, you need to stick to your guns - hold on to your thesis that you believe that cash could be more efficiently allocated. Work on proving or falsifying that thesis.
posted by b1tr0t at 4:53 PM on October 3, 2011

It would help to know the context of your project and who the intended audience is. Is this for an academic journal or for populist organizing? Do you want to persuade legislators, local reporters or board members?

The audience defines the argument you want to make, which will in turn inform the analysis you want to undertake.
posted by alms at 6:07 PM on October 3, 2011

I would say that it is more for populist organizing.

b1tr0t, I agree. I should've emphasized more in the original posting, that I'd like to know how to identify whether my working argument is a good one. If it's not, I'll move on and find another angle.
posted by kensington314 at 6:15 PM on October 3, 2011

Keeping in mind that any actual regulation enforcing this would be a joke, how about this metric?

1. Separate the business divisions into their respective industries.
2. Research the likelihood of failure and the rate at which revenues will likely decline based on similarity to other industries, plasticity of taste/demand, regulation, etc. You want to consider pretty much everything up to events so unpredictable that no planning helps much.
3. Research similar likelihood and rates to replace declining business with new business, factoring in reaction time. Probably some study of every new launch from an existing company in the S&P 500 and then an extrapolation if launches are getting faster or slower would be close enough.
4. Guesstimate what kind of deviation from the mean is reasonable to cover. Let's say two deviations in either way is not too conservative or too foolish.
5. The amount of cash that should be held is enough to cover those between periods within that window. So, if a historically volatile company like Apple could lose $30BB of revenue between the time nobody wants iWidgets and the next awesome product is launched, $5BB at the best and $55BB at the worst, $75BB might be a little high but not by much.

Also, when counting cash be sure to factor in what cash is held in other countries in addition to what's demanded by normal fluctuations in the business cycle that you are already considering. That money can't be repatriated without paying some prohibitive taxes. Many of these companies are waiting for a tax holiday, but don't know when it will come.
posted by michaelh at 6:16 PM on October 3, 2011

I'm working on a project where we would like to argue that big publicly-traded firms are sitting on a bunch of cash and should be investing it in the economy, their employees, the working class, you get the picture. (emphasis added)

You need to define "should" in this sentence. What does that even mean, that "should"?

Apple is sitting on something like $70 billion dollars in cash. They earn billions more every month. If they spent all $70 billion on building new roads and bridges in California they could certainly keep operating. They're making money, not losing it, so they could keep going fine without that $70 billion, and it sure would make California a better place to live if Apple donated all that money to improving the roads and bridges.

By your definition of "should", should Apple do that?

Do you mean "ultimately spending this money will help the company"?

Do you mean "spending this money won't hurt the company at all, or at least not very much, and it will do lots of other good things for society"?

Do you mean "if the Fortune 100 companies each spent 50 billion extra dollars next year, would the combined stimulative effect of that spending jumpstart the economy to such an extent that those companies would each make back their 50 billion dollars plus lots of other people would be making more money"?

Sorry, but it's hard to know if you're going to get the right answer when your question itself is so incomplete. I say this as someone who is basically sympathetic, someone who has worked in the field of Socially Responsible Investing and presented arguments to corporate boards that it will help their bottom line to do the right that. That's ultimately what you want to argue: that it will help the company's bottom line, plus it will help society's bottom line. That's Henry Ford's schtick about paying his workers enough for them to buy the cars they were building, writ large. But you've got to write it large. You can't run the numbers on just one company, you have to run them on the economy as a whole and you have to look a little deeper at the cash flow and the balance sheets these companies have and how changes in expenses and the cumulative effect on the economy will come back to them.

There's an argument there to be made, but first you need to get clear with yourself about what you're proposing, and whose benefit they should be doing this for.
posted by alms at 7:38 PM on October 3, 2011

I don't know where the canard that Apple has $70 billion in cash comes from. It has $76 billion in assets; not all assets are cash or easily convertible into cash. Please stop spreading this misinformation. Its balance sheet can be seen here.
posted by dfriedman at 9:39 PM on October 3, 2011 [1 favorite]

I'm really not sure there's any incentive to do this. If shareholders believe that a company is not making adequate use of its cash reserves, they have the ability to make changes in the company's management to encourage a more pro-active stance.

More than that, SEC filings show companies' financials. They don't necessarily show companies' business strategies. Maybe a company is planning to buy another one. Maybe they're planning a stock-buyback. Maybe they're planning to launch a new product line or enter a new market. Maybe they think that if they wait a few quarters/years, an opportunity will come along which will make them enough money to more than make up for the fact that those assets aren't doing much now. Considering that real interest rates are actually negative right now, the economy is basically stagnant, and real estate prices are still falling, that's not all that unlikely.

Here's the thing: sure, if a company spends and invests more, they'll ideally make more money this year. But if the choice is between going all in on an opportunity with a possible 1% return this year or sitting this one out and hoping that a 5% opportunity comes along next year, most people will sit this one out. Even if that opportunity doesn't come along for five years, the company will still be better off if it waits. So because there's so little incentive to invest right now, there's a lot of waiting going on.
posted by valkyryn at 7:00 AM on October 4, 2011

2nd'ing b1tr0t. In the Leveraged Buy Out (LBO) heyday of the 80s, companies were essentially asked to take out as many loans as possible until cash flows met interest payments. They were essentially required to run as fast as they could or the firm would fail. While this model has been largely discredited, there are some theoretical points in favor of it: corporations can deduct all interest payments from their income taxes.

To echo dfriedman, very little of the billions held in corporate coffers is actually held as physical dollars. The latest quarterly report from Apple, for example gives a breakdown of where their 75 billion is: "As of June 25, 2011, the Company had $76.2 billion in cash, cash equivalents and marketable securities, an increase of $25.1 billion from September 25, 2010."

The breakdown also shows you what they consider "cash and cash equivalents." But really most of those assets can be sold and returned to investors, as they're all deemed "marketable". The question then, is why you think these investments are inefficient and should be sold off so something else can be done with it. I mean, Apple is doing quite well with their money, so even if you took a rather socialist stance, you could always put confiscating their money until next year, when there's a good deal more of it.

I think it really helps to sit down and look at an individual company's statements, determine what you want to be done differently, and return that.
posted by pwnguin at 6:48 PM on October 4, 2011

Just adding on to the list of reasons why this will not be an accurate estimate. Consider a company like Bank of America, they are trading at a value that is below their holdings of assets. The reason for this is that everyone knows they may be held responsible for litigation expenses related to the subprime crisis, but no one knows how much they will be held responsible for. If Bank of America did not store extra cash on hand they would have a high risk of bankruptcy.

So if you don't have a way to take into account the risk of future negative events for the company, you may dramatically over estimate the number of companies that have "excess" cash on hand.


One concrete proposal that might decrease all the company hoarding would be to reduce taxation of dividends. As it stands now, company profits that are paid out as dividend are taxed more highly than if the company kept the money and increased the company value instead (since long term capital gains are taxed at a lower rate than dividends).
posted by vegetableagony at 7:14 AM on October 13, 2011