looking at corporate cash balances

AAPL as a model global company

Many publicly-traded US companies have huge cash balances relative to their stock market value.  AAPL is a good example.

The company had just short of $120 billion in cash plus marketable securities on its balance sheet as of June 25th.  That’s about 20% of the stock’s total value at last Friday’s close.  Let’s say 80% of that cash is held overseas in countries that levy little or no tax on corporate earnings.

Like many global companies, AAPL’s tax rate–25.3% during the first nine months of its current fiscal year–is substantially below the 35% statutory rate in the US.  (Yes, the US rate is much higher than in the rest of the world.  Yes, a good part of the reason for AAPL’s lower rate is that it earns money abroad that it declares to be permanently invested overseas and therefore doesn’t repatriate to the US.)

analytic issues

Today’s dominant stock market view is that cash is cash, no matter where it’s located, and that earnings are earnings, no matter how lightly they’re taxed.

In contrast, when I began working on Wall Street in 1978, attitudes about recognizing earnings in low-tax areas and about holding cash balances there were far different from what they are today.

Specifically, in those days, investors in the US mentally subtracted from cash balances the home country tax that would be due if the money were to be repatriated and used for shareholder dividends or domestic capital expenditure.

In the UK, brokerage house analysts went further than that.  They did that work for you. Their written recommendations commonly contained, in addition to actually reported earnings, the same numbers “normalized” as if the firm had repatriated all foreign earnings and paid a full tax rate.  Brokers gave their estimates the same dual treatment.

two views:  what’s the difference?


This is pretty straightforward.  For profits on business concluded by a US company in, say, Hong Kong, the corporate tax rate is zero.  If the firm wants to distribute this money as dividends, it first has to be sent to the US, where it is subject to the 35% Federal corporate tax–and possibly to state tax as well.  If this possibility is all an investor is concerned about–cash in his hands rather than in the company’s (a view the dividend discount model explicitly endorses/encourages), then foreign cash balances are worth substantially less than domestic ones.

Figuring out how much less is more difficult,  That’s because a company gets a credit against tax due to Uncle Sam for any tax paid to the foreign country.  To make a stab in the dark, AAPL’s cash pile is probably worth $20 billion less to our totally dividend oriented investor than its balance sheet carrying value.

On the other hand, if you have faith in company management to maximize the value of the corporation, you’re probably willing to believe that holding the cash balances abroad is the best use of the money.  Maybe the funds are being earmarked for reinvestment there, either through purchase of capital equipment or maybe an acquisition.

So you’re less worried about the fact that the money is in a foreign bank.  You’d also think it would be crazy to repatriate the cash, lose a large chunk to taxes, and the ship the funds back out of the US to pay for foreign expansion.

earnings per share

AAPL’s corporate tax rate for the first nine months of 2012 is 25.3%.  If its pretax total were subject to tax at 35%, eps for AAPL would be about 15% lower.

Another way of saying the same thing is that if we adjusted the AAPL PE multiple to reflect a full US corporate tax rate, it would be about two PE points higher.

why write about this?

As I mentioned above, conventional wisdom is that these distinctions don’t matter.  But this is an expression of investor preferences or “taste,” as academics might put it.  And these are subject to change.  After all, these preferences were substantially different a few decades ago.

My reason for writing is that I think preferences are starting to change again.

Maybe it’s the more subdued state of world economic growth.   Maybe it’s the aging of the Baby Boom and that cohort’s increasing interest in dividends.  Maybe I’m just wrong.  But I think that investors are beginning to become more aware of differences in taxation of profits and of the geographical location of corporate cash.


If so, companies sporting low corporate tax rates– predominantly ones with emerging markets exposure, in my view–may be subject to a lot more backing and filling than is commonly thought as the market discounts the possibility that they’re more expensive than they seem.