You’d be uncomfortable if you didn’t have enough cash to pay your bills, right? Well its the same story for companies-its good to have cash to cover your short term liabilities. I was curious how balance sheets looked today by a measure called the cash ratio, which is a convenient measure of short-term liquidity. The results revealed an amazing trend in one corner of the market…
The cash ratio is calculated as cash (and short term equivalents) divided by all current liabilities, where current liabilities are short term debt, accounts payable, income taxes payable, and misc other items.
So how do stocks look? Do they have their liabilities well covered? Here is what the market’s cash ratio looks like over the past few decades (higher is better).
Pretty damn good looking trend, eh? Well, the market has changed a lot. The majority of this trend is coming from one sector: cash rich technology stocks. Here is the same ratio broken out by sector:
These technology companies are like Scrooge McDuck, swimming in dough. All U.S. listed technology stocks are sitting on more than $800 Billion in cash and short term equivalents…almost double the next closest sector. Oh, and these numbers don’t include long-term investments (Apple alone has $130B categorized as long term investments, which many consider part of their cash hoard).
as of 11/30, all U.S. listed stocks, Cash + Short Term Equivalents
Any thoughts on this trend? I am amazed by the ability of these technology firms to generate cash without significant liabilities. No wonder Silicon Valley is booming.
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Acceptance;
Millennials love paying too much for being in the fast lane with techno glitz.
This is America. It’s not a trend it’s the Way.
I have also heard, that the SP500 is sitting on "record levels of cash" however, many smart analysts like Hussman point that this has been accomplished through equal like record levels of debt issuance. I don’t think this may be the technology sector per say, so it does not disprove your conclusion…..but its something to keep in mind.
Very interesting but i wonder about the influence of the massive tech giants lika aapl msft goog etc. A median ratio would perhaps help or the median and average excluding say the top and bottom 2 percent for each sector.
A comparison vs fcf per share and per ev by sector would also be interesting to see over time how much of it is internally generated and how much is raised
Yes there has been lots of debt issuance, which makes sense given how cheap it is. I love the "stakeholder yield" factor, which scales financing cash flows by market cap. This would reward companies paying dividends and buying back shares, but punish those issuing debt or equity. It works very well (its one of the five factors I explore and recommend in my book)
Some observations and two possible explanations that are not mutually exclusive: your findings seem to neatly mirror the capex spendings by sector that you displayed in an earlier post (http://www.investorfieldguide.com/20141117how-much-capital-is-needed-to-produce-sales). Less capex, then, equals less cash. Possibly, the IT sector generates so much cash because its companies do not need to invest in costly fixed assets, and the increasing trend could reflect a declining need for them over the last decades. The opposite is obviously true for utilities (not concerning an opposite trend, though). It might also be a reflection of the popularity of IT companies as it is fairly easy for them to raise capital since they have historically and until recently been far higher valued compared to the market in general as you showed in a previous post (http://www.investorfieldguide.com/2014922tech-stocks-can-be-great).
If we posit that the first explanation is correct, that it is the consequence of the IT sector requiring less capex and therefore generating more cash on less assets, it is interesting to note that it doesn’t equate with great investment results. Your father’s book, What Works on Wall Street, contained a table (24.31 on p. 545) showing the sector returns for a a similar time period that you examine in this post. The IT sector performed the worst while utilities, despite their relatively anemic cash generation, had returns that were about average. Presumably this is due to the always trendy IT sector being highly valued and the always dull (and sometimes controversial) utilities sector being lowly valued. I find this phenomenon very interesting — the most profitable sector had the worst returns! I guess it just goes to show that valuation trumps everything and is hence the first and last factor a value investor should take into consideration.
As mentioned, you showed in an earlier post that the IT sector recently has become cheaper overall. If this recent trend turns out to become the norm, it might pave the way for value investors to consistently be able to take advantage of its cash rich operations at low prices, thus setting the scene for excess returns. However, I think it’s safer to assume that the sector’s valuation is more likely to revert to its around its historical average, which it did after the last time the IT sector closed in on the market in general in the late ’80s. Since the US market overall today is very highly valued, ‘cheap’ in relation to the market often means overvalued anyway. So it’s not necessarily that IT stocks are cheap, it’s that the entire market is expensive.
Correction of a mistake in my previous post: I of course meant that "Less capex, then, equals more cash."
My thought is technology companies cannot hoard cash for ever, do they?