Back again for another Q&A. Keep those questions coming!
I'm a newbie so be gentle. What is change in non-cash working capital all about? I always see it on the income statement but can't figure out what it really is. Thanks -- Ken Deck
Net working capital is defined simply as current assets minus current liabilities. In a nutshell, the figure shows how much money the firm has on hand to fund short-term growth opportunities. Each component of the equation includes a host of liquid items, and cash plays only a fractional role in the whole mix. So when you see a notation for changes in non-cash working capital, it could be driven by anything from accounts payable to inventory to income taxes due. Few reports really dig into the nitty gritty details, so often we're just left guessing.
In the end, it may not be a big deal. Viewing the amount of net working capital that a firm has in isolation tells you very little about the company's prospects anyway. A better idea is to compare it to net sales (or revenues) and plot the trend over several years. A steady or rising trend shows that the firm has enough money on hand to fund future growth and expansion, while a declining trend might indicate either a maturing business or a company about to get into a liquidity crunch.
Andrew, America Online (AOL) has an upcoming stock split and an imminent takeover of Netscapeundefined. The deal was to be 0.45 share of AOL for each NSCP share. If the takeover occurs after the stock split (as seems likely), won't the value received for each share of NSCP be less after AOL's split than the amount agreed to when the AOL Netscape deal was done? -- Ed Shaffer
Wouldn't that be great? Firms could just snap up any company they wanted in exchange for common stock and then split it at the eleventh hour to land a real bargain. Heck, why stop at mere two-for-one split when you could take 90% off the top under a ten-for-one adjustment?
I never cease to be amazed by the public's fascination with stock splits as if taking a bag of 10 oranges and dividing it into two bags of 5 constitutes some kind of market wizardry from which gains magically materialize out of thin air. (See my previous
"Stock Split Primer" ) Once again, stock splits in and of themselves neither create nor destroy wealth. Every single shareholder retains
the same value and proportional claim on the company in the post-split world as in the pre-split one -- and that includes any deals based on company stock.
The bottom line is that, other than the apparent third-grade emotional charge that some investors get from owning 200 shares at $10 instead of 100 at $20, stock splits are pretty much meaningless number shuffling.
Greta, The measure "earnings divided by price" is touted as a useful number because, unlike "earnings per share," it gives you a yield that you can then compare directly with the yields of other assets such as bonds, gold, art, etc. Is this valid and reliable across all asset classes? Thanks in advance. -- Jim Sullivan
Your measure is just a different way of viewing the P/E ratio of a stock as an earnings-to-price figure instead of price-to-earnings. Frankly, I don't see the point.
Since the figure is merely the reciprocal of a standard valuation measure, stocks with P/E ratios of 20 will always return a "yield" of 5% and so on. No real tricks here.
In addition, the idea of comparing common stocks directly with assets like bonds, CDs, and precious metals is like asking which is better, a chainsaw or a sledgehammer. Each has its own risk-reward profile, and each performs well to carry out the task for which it was designed. Treat them as interchangeable and you're in for one dangerous, blade-dulling, concrete-chipping experience.
Dear Andrew, Can you please talk about how to use the price-to-sales ratio? I have read that a ratio less than 1 outperforms the market in the long run. Thanks -- Stephen Wolinski
In theory, the price-to-sales ratio is another value measure akin to P/E. The idea is that you're benchmarking a stock's price against the firm's gross revenue stream to assess it's relative cost in the marketplace. When used in isolation, however, the ratio has some serious and potentially lethal drawbacks.
One big factor is that the P/S ratio tells you absolutely nothing about the cost structure of a firm. A firm raking in $1 million in gross sales with $2 million of expenses each year is hemorrhaging cash and probably deserves a rock-bottom price-to-sales ratio.
Because the measure doesn't require a firm to have positive earnings (unlike P/E) it's sometimes used as a valuation measure for fly-by-night upstarts and the latest batch of dot-coms. Used on sectors notorious for negative earnings, the measure may be able to tell you if say,
is more expensive than
, but it doesn't indicate whether the entire market segment is overvalued or undervalued.
In short, use with caution and in conjunction with other earnings-based indicators. Making some kind of blanket statement that P/S ratios less than 1.0 are always good buys seems dangerous at best.
Dear Andrew, Thanks for a fine primer on convertible preferred shares. Can you supply a source or two where I can find a listing of same? Does anyone publish a list of convertible preferred shares currently on the market along with conversion features and maturity dates? Any leads you may have for me would be appreciated greatly. CHEERS! -- Jack Sweeney
One of your fellow
readers came through with the goods on this one. I haven't checked out the site so I'll let him speak for himself.
Andrew, You might want to refer your readers to ConvertBond.com -- a great site if anyone wants to learn about converts. I think they were featured on CNBC some time back. -- Subodh Nijsure, Network Aware, Inc.
If anybody finds the site useful, or not, please let me know.
Andrew Greta is a business student and onetime stockbroker who lives in West Lafayette, Ind. At the time of publication, he held no positions in the stocks discussed in this column, though positions can change at any time.