Excluding cash P/E

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Does anyone know what excluding cash P/E mean? Why take away cash ??
Thanks
 
If I sell you my wallet for $100, but it has $20 in it, how much are you really paying for it?
This only works if the company has net cash - if they have more short and long term debt than cash, then you really can’t do it, because the cash isn’t “free and clear”. Take cash, minus short and long term debt, and then you’ve got “net cash”. Net cash can be subtracted from share price to give you the price you’re paying ‘for the wallet’, as opposed to the cash + wallet. Get it?
Edit: I’ve taken you to the five-yard line. You should be able to figure out how to calculate cash-adjusted P/E from here. Go on, I have faith in you.
 
Thanks a lot for your clear explanation.
 
> Take cash, minus short and long term debt
I think that’s wrong. “Price” (market cap) already has debt removed. Don’t remove it a second time.
Market cap has two components:
1. value of earnings
2. value of surplus assets: paintings lying in the basement, unused real estate, surplus cash, etc.
The problem is that, if surplus assets remain level, then P/E changes (falls) as the level of earnings rise – because the proportional contribution to price from surplus asses falls. To avoid this apples/oranges, you should adjust market cap to reflect just earnings power as follows:
MC’ = MC - (cash - minimum_operating_cash)
Then do your P/E calculations. When you go to price the equity, at the last moment add back the surplus cash to MC.
 
^^I dont think he means to subtract debt from MC bc as you pointed out, it has already been removed. I believe he means to remove excess cash.
 
I think the ‘answer’ here is to take MC, subtract net cash and recalculate P/E. So if a firm is trading for $10, makes $1 EPS but has net cash of $5ps you may see a comment in a broker report along the lines of ‘company ex is trading at only 5x P/E excluding cash - what a bargain!’
Darienhacker, I’m not sure I follow your explanation. Is this a methodology you use in the real world?
 
DH, not sure I understand your definition of surplus assets. I would think surplus assets would be any asset that is not counterbalanced by some debt (i.e. BV of Assets - Total Liabilities = BV Equity)
Then, Market cap = BV of Equity + PV(Future Earnings discounted at cost of equity)
We can reduce BV of Equity by the amount of cash on the balance sheet. However, since some small amount of cash is necessary as a cushion just to make sure bills can be paid on time without having to liquidate other assets, you’ll add a small bit back to be the company’s true market cap. Then compute on a per share basis and/or use to compute a revised P/E ratio.
Is this what you meant, or am I missing something about excess cash and excess assets?
 
Carson Wrote:
——————————————————-
> I think the ‘answer’ here is to take MC, subtract
> net cash and recalculate P/E. So if a firm is
> trading for $10, makes $1 EPS but has net cash of
> $5ps you may see a comment in a broker report
> along the lines of ‘company ex is trading at only
> 5x P/E excluding cash - what a bargain!’
>
What Carson said.
 
> I think the ‘answer’ here is to take MC, subtract net cash
no – if by net cash you mean cash adjusted for debt. Don’t adjust MC for debt.
> DH, not sure I understand your definition of surplus assets.
Any asset not required to generate earnings.
When it comes to cash, the standard approach is to find the operating cash required to run the business – e.g., cash sitting in cash registers, overnight float, earmarks for A/P, etc. Most firms carry more cash than this – that extra cash is potentially a surplus (wasting) asset that incurs cost of carry and opportunity cost. A quick calc of surplus cash would be current cash less the minimum cash level over the past few years.
Surplus assets obviously contribute to market cap, but they don’t change in value as earnings change. Naive P/E analysis assumes they do.
No need to bring in BV’s here.. unrequired/misleading complication.
I’m not sure why people are bringing in debt here. Shareholders have a claim that is essentially the annuity value of NI. If the firm (aka, the “wallet”) has surplus assets in it – nonoperating cash, paintings, $20 bill sitting in an envelope – those surplus assets increase market cap dollar for dollar. Once you do this however P/E gets a little funny, and adding $1 to earnings will _not_ increase market cap by $1 * P/E.
There is no need to bring debt into this.
 
I mentioned BVs because how do you know if the cash is “net” if you aren’t using book values (though you’d need to value book assets at their current replacement value rather than historical cost)?
 
Wouldn’t you also need to adjust the denominator to take out interest income earned on the excess cash?
If a firm is flush with cash, the interest income could be significant even at just 1.5% annually. Isn’t this the main reason why you would even adjust the P/E for cash? To get a multiple on what the earnings are on the core operating business?
 
This is why P/E is such a meaningless and confusing measure of value.
The surplus cash/net debt issue is just one of the many reason rendering P/E only marginally useful and at most times down right misleading.
EV/EBIT, EV/EBITDA, EV/Cash Flow should be looked at in addition to just simple P/E. The only advantage of using P/E is simplicity - it takes one calculation step. But perform a few more calculation to get EV/EBIT and you get a much clearer picture of a company’s value.
 
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