The Price of Excess Cash
More recently, Sherlund calculated a new P/E for Microsoft by deducting only the $3-a-share special dividend rather than all of Microsoft's cash.
That second approach may make more sense because investors know exactly what will happen with that $3 a share, whereas what Microsoft will do with the remaining cash in its coffers is less certain.
"In a case like Microsoft, where management has committed to returning cash to shareholders, you can value that cash at face value," said David Merkel, a senior analyst with Hovde Capital and columnist for RealMoney.com. He believes the only time to deduct a company's cash on a dollar-for-dollar basis is when there is a definite liquidity event, such as Microsoft's special dividend, that truly gives investors control of the cash.
In the early 1980s, cash had that dollar-for-dollar value because so many corporate raiders were putting the cash on their balance sheets for use in buying other companies.But in today's world, a more likely use of cash might be buying back stock -- a step Microsoft is taking in addition to its special dividend. But announcing a buyback plan is no guarantee a company will buy the shares, Merkel noted. Hence, he would only deduct 90 cents for every $1 of cash from a stock's price to value a stock because of uncertainty as to whether management will use that cash as it says. Another situation in which you might not give a company full credit for its cash is if you don't fully trust management, perhaps because it has a bad track record with acquisitions or expanding into new markets, Merkel said. Rich Parower, portfolio manager of the (SHGTX) Seligman Global Technology Fund , echoed that argument. "We do try to reflect
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