Education

Companies without debt and with much liquidity

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There are companies that not only don’t have debt, but also have a large amount of accumulated cash(ahem…Apple)

A good analogy is to think of buying shares of these companies as like buying a flat, knowing that in one of the closets there are a lot of bills that will become the property of the buyer at the time the transaction is made.

If you buy a flat for $100,000, but it has $20,000 in the closet, the real price of the flat is $80,000, although first you have to pay $100,000 to immediately access the closet that has $20,000.

The case of the shares is slightly different because the minority shareholder buying shares of these companies can not decide what is done with that liquidity, since this decision still rests with the managers of the company. If you buy a stock for $10, but the company has a value of $2 additional dollars per share we could say that the purchase price is $8. But the minority shareholder can not ask the company to deliver their $2.

This liquidity can be used in several ways:

  • Distribute as an extraordinary dividend.
  • Use it to buy shares of the company itself to be amortized, which increases the earnings per share (EPS) and the dividend per share of future years.
  • Re-invest into new business. This can be good, if new businesses are profitable, or bad if these new businesses waste money without benefitting the shareholders of the company.

The first two cases clearly benefit the minority shareholder, while in the third case, liquidity may disappear in the event of a poor choice of new investments, or increase significantly if the new business become very profitable.

In addition to the value of liquidity in itself, the fact that a company is able to develop its business in such a way that usually generates such excesses of cash that allow it not only not to have debt, but even to increase progressively that liquidity is something that speaks volumes about the good quality of the managers of said company. This factor is an intangible that can not be quantified per se, but that should be taken into account by long-term investors.

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