Wednesday, February 2, 2011

Cash Levels High Or Low?

If you follow the markets, you have no doubt heard the bull argument that companies are holding record levels of cash, and therefore that should eventually translate into future dividends, buybacks and investments, all of which should drive the market higher. A quick look at S&P 500 cash levels over the last few years does indeed show this to be the case:


But is the index's cash level, by itself, of any use? At the very least, it should be compared with index debt levels. Index debt levels have been on the increase for several years, and only recently have companies in the aggregate decided to start paying it down. By subtracting aggregate cash levels from aggregate debt levels, we can get an idea of how indebted the index is. The following chart shows the net debt level of the S&P 500:


While net debt (debt less cash) is on the way down, it only recently returned to early 2007 levels. Was the market in early 2007 undervalued? Future historians will probably say no. And yet if the index's cash position, relative to its debt, is high today, so it was in early 2007 as well.

The media jumps on attention-grabbing stories such as the record cash levels that corporations are currently holding. But the onus is on you, the investor, to put their stories in proper context. Does record cash mean a whole lot when the capital stock is also at record levels? Does the size of aggregate cash holdings mean anything without a comparison to the size of debt levels? Investors must always go beyond the superficial sound bytes to figure out what's really going on.

5 comments:

Water Investor said...

can you please disclose the source of the data used in the charts?

jsatt said...

This appears to be a good indicator. However the values can and do change in 3-4 quarters. So it may be dangerous to make conclusions from older data such as in these charts??

Anonymous said...

Saj

Do you put these charts together yourself or do you get them from somewhere? If you do it yourself, where do you get the data?

Thanks

Saj Karsan said...

Hi guys,

Sorry, I should have disclosed the source in the post. I used a Standard and Poor's paper, link to web version here

Anonymous said...

Thanks Saj, very interesting work!