Comments (19)

Aug 8, 2014

Market Cap is price*number. That price will implicitly take account for the net debt or cash balance.

Aug 8, 2014

http://www.investopedia.com/terms/m/marketcapitali...

sorry bro, your friend is right, but there's a difference between price & value. market cap is what the market thinks the company is worth. what it is "really" worth is dependent upon your philosophy, there's no way to know whether or not the market includes the value of the company's cash in pricing the stock, that's up to the individual investor, but the definition of market cap is price x shares outstanding, period.

Aug 8, 2014

Whoops... Lolll. Sounds like you owe your friend a beer.

Aug 8, 2014

Another question - if a company spends $2 billion in cash on paintings (e.g. no future return), are you saying that the market capitalization may or may not be impacted? In my mind, it would decrease by $2 billion (if not something very close) for this specific isolated event.

Aug 8, 2014
gibberish_sand:

Another question - if a company spends $2 billion in cash on paintings (e.g. no future return), are you saying that the market capitalization may or may not be impacted? In my mind, it would decrease by $2 billion (if not something very close) for this specific isolated event.

If a company literally burned $2bn cash, the price of the stock would likely decrease (consequently market cap fall), and probably fall by more than the cash because management are obviously retarded.....

You need to step away from the thought process of X+Y+Z+O = value. And i'll refer you to my first comment saying that cash is accounted for. You're basically questioning how people value companies, there's it too much to cover, but i'll say that how cash is viewed within a company depends on the company itself.

Aug 8, 2014

Also why would a rational investor not account for cash, assuming its not trapped or encumbered by debt? A $ of cash is a $ of cash, isn't it? I can understand for the value of operations (EV) people can have differing opinions but why would there be any debate over how cash is valued?

Aug 8, 2014

This was an extreme example - the debate at hand was for a lawsuit settlement (with no future earnings impact). I understand that the impact on stock price cannot be predicted as millions of investors will make their own conjectures but one conjecture could be that the market cap will fall by $2 billion, which is absolutely rational!

Aug 8, 2014
gibberish_sand:

This was an extreme example - the debate at hand was for a lawsuit settlement (with no future earnings impact). I understand that the impact on stock price cannot be predicted as millions of investors will make their own conjectures but one conjecture could be that the market cap will fall by $2 billion, which is absolutely rational!

Hahahaha, yerrrr enjoy your rational markets there.....

Aug 13, 2014
gibberish_sand:

This was an extreme example - the debate at hand was for a lawsuit settlement (with no future earnings impact). I understand that the impact on stock price cannot be predicted as millions of investors will make their own conjectures but one conjecture could be that the market cap will fall by $2 billion, which is absolutely rational!

Your example is funny because Dennis Kozlowski spent some outrageous amount on paintings and antique furniture at Tyco a dozen years ago (I wouldn't doubt near $2B and he embezzled more). Tyco lost far more than $2B in cap and he went to prison. So your extreme example has happened.

Aug 9, 2014

The market cap includes the amount of cash the company has, regardless of what investment philosophy any investor has. If someone stole $2bln out of the firm's bank account, your market cap will drop by at least $2bln. One may be able to argue that you can lose more if there are collateral effects - e.g., you have poor internal controls, so what else could be wrong? However, that effect would be case-specific and there is no way to tell given this general question.

Aug 9, 2014

Technically a stocks price is based on FUTURE dividends... If you wanted a textbook answer.

Aug 9, 2014
couchy:

Technically a stocks price is based on FUTURE dividends... If you wanted a textbook answer.

PV of expected future cash dividends is one way to look at it also. What does the firm give up when they pay cash dividends? Cash. The stock price falls by the amount of dividends paid, i.e., the stock price falls by the amount of cash you pay out. Therefore, removing $1 of cash from the company equals a market capitalization drop of $1.

Aug 10, 2014
fin_geek:
couchy:

Technically a stocks price is based on FUTURE dividends... If you wanted a textbook answer.

PV of expected future cash dividends is one way to look at it also. What does the firm give up when they pay cash dividends? Cash. The stock price falls by the amount of dividends paid, i.e., the stock price falls by the amount of cash you pay out. Therefore, removing $1 of cash from the company equals a market capitalization drop of $1.

yes and no, plenty of companies operate the way you described, but just as many do not. You have the general or average idea but what everyone on this thread is saying is that it's dangerous to generalize that statement.

Also your argument only works if the expected dividend is materially affected in the short to medium run.

Aug 12, 2014

I'm not sure I follow any of the statements you just made. Is your argument that if a company pays a cash dividend of $1 per share (i'm not talking about changing dividend payout but simply the act of paying out the cash dividend), holding all else constant, its stock price will not fall by $1? If yes, what is the basis, rationale, or support for such a claim?

Aug 13, 2014
fin_geek:

I'm not sure I follow any of the statements you just made. Is your argument that if a company pays a cash dividend of $1 per share (i'm not talking about changing dividend payout but simply the act of paying out the cash dividend), holding all else constant, its stock price will not fall by $1? If yes, what is the basis, rationale, or support for such a claim?

lets say your low growth stock pays a constant dividend, so it is built into your shareholder's expectations, and since there's low growth, your investors don't expect capital gains (utilities for example).

If the company burns away a chunk of cash, but it doesn't really affect its ability to pay the dividend investors expect, the stock really wouldn't move.

This only works if the investors just want the dividend, which is exactly how some stocks operate. If it's a shareholder friendly stock that pays special dividends, or perhaps can be acquired, then the residual value matters a lot more, and will affect the pricing of the stock.

Alternatively, there are stocks where we expect cash to be burnt and so it's assets matter less than the potential capital gain opportunity in the future. The cash matters a lot less than perhaps an FDA approval or an in-licensing deal etc.

Aug 13, 2014
couchy:

lets say your low growth stock pays a constant dividend, so it is built into your shareholder's expectations, and since there's low growth, your investors don't expect capital gains (utilities for example).

If the company burns away a chunk of cash, but it doesn't really affect its ability to pay the dividend investors expect, the stock really wouldn't move.

This only works if the investors just want the dividend, which is exactly how some stocks operate. If it's a shareholder friendly stock that pays special dividends, or perhaps can be acquired, then the residual value matters a lot more, and will affect the pricing of the stock.

Alternatively, there are stocks where we expect cash to be burnt and so it's assets matter less than the potential capital gain opportunity in the future. The cash matters a lot less than perhaps an FDA approval or an in-licensing deal etc.

Let me see if I understand your example by breaking down what you said. I think what you're saying in the first two paragraphs is the following. Suppose you have a firm that generates $3 of cash each year into perpetuity and pays out $2 of cash dividends each year into perpetuity. They then burn the $1 of cash each year that they do not pay out. The stock price will always be the PV of the $2 of cash dividends into perpetuity (ignoring the collateral effects of burning cash - e.g., investors may think managers are retarded for burning cash so the stock price drop will be bigger).

Did I get your hypothetical correctly? If so, the problem with this hypothetical is that the "true" stock price (i.e., the stock price prior to burning the cash) is the PV of $3 of cash into perpetuity. The reason why the stock price is only the PV of $2 of cash into perpetuity is because it dropped by an amount equal to the PV of $1 of cash into perpetuity. Put differently, if one day you stop burning the $1 of cash, your stock price will go up by the PV of $1 into perpetuity.

The third paragraph basically follows the same rationale as above. Regardless of whether the investor wants only the dividend or not is not of first-order importance to the value of the firm. The ability of the firm to generate free cash flow is what is important. The reason why the stock price drops when you burn the cash is that investors can get a "special dividend" or a liquidating dividend had the cash not been burned. By burning the cash you deprived the investors of receiving that "special dividend." Therefore, burning the cash causes the stock price to go down.

Also, the choice between dividends and capital gains is irrelevant (ignoring taxes or assuming taxes on dividends/capital gains are the same). This is the Miller and Modigliani proposition and a fundamental tenet of finance.

Aug 14, 2014

The question as stated would generally be inferred as asking whether the "Cash" account is included in the calculation for market cap, in which case the answer is no.

A different question might be whether the amount of cash held by a firm is one of the determinants of market cap, to which the answer is yes, but one could replace "amount of cash held by a firm" with virtually anything even tangentially related to the company and the answer would still be yes, making this a pointless question.

In short, your friend is correct.

Aug 15, 2014

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