I've seen some people look at P/E for companies with a net cash balance on a net of net cash basis, and I'm having some trouble wrapping my head around this.
I understand that market cap includes cash, so P/E ratios can be wonky for companies that have large cash balances. What's the logic for only stripping out net cash in that case?
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Bump anyone?
It’s excluded to make the actual business operations of two companies more comparable (from a multiples view). Excess cash is already included in market cap, so it skews the numerator of P/E.
If you had two identical companies, but one had a ton of cash, it would ‘trade better’ merely due to the cash balance inherent in its share price. Remove that effect, and you have a clearer view of whose actual forward operations are more valuable.
Got it, thanks. Makes sense that excess cash is included in market cap.
What I've been seeing on a lot of comps pages for tech companies especially that are often net cash, is P/E (net of net cash). What's the logic for only stripping out net cash, and not all of the company's excess cash (assumingexcess cash = cash in excess of restricted / necessary balance)?
When you own a stock, assuming all debt obligations are met, you and your fellow shareholders are entitled to i) the net income [$X] and ii) the cash held by the company [$Y]. That’s why when the company pays a cash dividend, the share price declines by (roughly) the dividend/share (ex. signaling effects, etc.).
Technically you’re right; all cash is included in market cap calc. But for P/E ex. cash impact, you’ll usually see a min cash assumption. Going back to the two company strawman, let’s say they’re almost-identical this time — same earnings, same amount of cash on BS. But in this case, one requires a minimum amount of cash to run its business; the other requires zero. Remember, the goal of P/E ex. net cash is determining exactly how much a company’s actual operations are “worth.” In the cash-heavy company’s case, it’s not really fair to say the company would still generate the same net income [$X] if it had no cash, so some of that cash [$Y] isn’t inherent in the share price since there’s some ‘overlap’ in generating [$X]. Thus, you’ll only see a non-critical portion of the cash subtracted from the numerator of P/E.
This is really helpful, thanks.
Apologies if I wasn't clear - when I was saying net cash was stripped out, this was calculated as the delta between cash and debt. So for a company that had $100 cash balance and $50 of debt, only the $50 net cash balance was being stripped out of equity value. Is this the same logic, that the net cash is the excess cash balance beyond the critical portion, where the critical portion is what could be used to net against debt?
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