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5 Stocks That Are Cheaper Than You Think

By Matt Koppenheffer - Updated Apr 6, 2017 at 11:44AM

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Large cash hoards may be obscuring both value and profitability available in today's market.

There are a lot of reasons to dislike excess cash on a company's balance sheet. The simple fact is that most CEOs are not Warren Buffett and so capital allocation is probably not one of their foremost skills.

As a result, bad things can happen when companies start building huge stockpiles of cash. One of the worst possibilities is that the CEO decides it's time to take over the world and shareholder value gets kneecapped as the head honcho negotiates a bunch of large, overpriced acquisitions. Also potentially damaging are big share buybacks. Though these are typically pitched as shareholder friendly, management teams often end up throwing big bucks around when the company's stock is anything but cheap.

More innocuous, but suboptimal nonetheless, is allowing the cash to sit around gathering dust. Particularly with safe, secure investments yielding next to nothing these days, cash that a company has no plans for really does absolutely nothing for shareholders.

However, gobs of cash on the books may also obscure the true value and performance of a company. For investors who dig into the numbers, that may create opportunities others are overlooking.

Cash, the master magician
There are two primary areas where cash might throw investors off the scent of a good investment: valuation and return on equity.

The value of a company with a ton of cash should be calculated in two separate pieces: the value of the excess cash and the value of the operating business. For obvious reasons, the cash should be valued dollar for dollar, while the operating business can be valued any number of ways.

Any investor who assumes the valuation reflects the operating business alone and tries to calculate, say, a price-to-earnings ratio based on the full price tag will end up thinking that the market is giving the business a much heftier valuation than it actually is.

Meanwhile, a company's return on equity is meant to reflect the returns that a business can generate in relation to the capital that's been invested in the business. Extra cash that a company keeps around is capital that hasn't been invested in the business and yet still inflates the company's equity. That drags down the company's overall return on equity.

So with a wave of its hands and a tap of its wand, the illusionist Excess Cash can simultaneously make a company look more expensive and less profitable.

A cash-rich quintet
There are a lot of companies sitting on a ton of cash right now. Here are five that might look a lot more appetizing to investors if they unloaded their cash hoard.

Company

Net Cash

Current P/E

Ex-Cash P/E

Current ROE

Ex-Cash ROE

Google (Nasdaq: GOOG)

$26.5 billion

21.6

18.4

18.4%

58.2%

Cisco (Nasdaq: CSCO)

$23.9 billion

19.4

16.1

15.8%

34.3%

eBay (Nasdaq: EBAY)

$4.5 billion

10.9

9.2

17.2%

25.0%

Dell (Nasdaq: DELL)

$6.2 billion

17.0

12.0

25.2%

NM*

Western Digital (NYSE: WDC)

$2.4 billion

5.5

3.7

29.7%

65.0%

Source: Capital IQ, a Standard & Poor's company, and author's calculations.
P/E = price-to-earnings ratio.
*NM = not meaningful; Dell's net cash exceeds its equity value.

It's hard to classify Google's ex-cash P/E as "cheap," but when we consider the amount of cash the company is holding, the valuation definitely looks more reasonable. What's more striking, though, is how much of an impact Google's cash has on its equity returns. Without the drag from its cash, Google's capital-light, highly profitable business model is shown in high relief.

Stripping out Cisco's cash, we actually end up with a below-market multiple on what I consider one of the very best tech companies, if not one of the very best companies, period. Cisco may be a different story than the rest of the companies here, though, since it's one of a select few companies -- Oracle (Nasdaq: ORCL) being another -- that has made great use of acquisitions to grow and prosper. So it may actually behoove investors if the company keeps some cash available for takeovers.

While Google and Cisco are largely looked at as currently successful companies, the valuations for both eBay and Dell reflect the market's perception that both businesses are facing tough times. With brutal competition from the likes of Hewlett-Packard (NYSE: HPQ) in what's become largely a commodity business, I find it hard to get too excited about Dell. eBay, however, not only carries a lower valuation than Dell, it also packs more excitement -- particularly when it comes to the PayPal-driven payments side of its business.

But perhaps the most intriguing stock here is Western Digital, which isn't exactly a growth company working in an exciting, new technological field. In fact, it's quite the opposite. The market sees flash and other solid-state storage from companies like SanDisk as a mortal threat to WD's core disk drive business.

However, when we strip out the cash that WD already has on its books and consider the extremely healthy cash flow that the company is producing, I come to the same conclusion my fellow Fool Eric Bleeker reached when looking at WD competitor Seagate: It may just be too cheap to pass up.

Now it's your turn to chime in. Do you think cash-hoarding companies are throwing investors off the scent of good investments? Head down to the comments section and share your thoughts.

While these cash-rich companies may have piqued my interest, my first love will always be companies that pay healthy dividends.

Google is a Motley Fool Rule Breakers pick. eBay is a Motley Fool Stock Advisor recommendation. Motley Fool Options has recommended a bull call spread position on eBay. The Fool owns shares of Google and Oracle. Try any of our Foolish newsletters today, free for 30 days. The Motley Fool has a disclosure policy.

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy assures you no Wookiees were harmed in the making of this article.

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Stocks Mentioned

HP Inc. Stock Quote
HP Inc.
HPQ
$33.58 (0.96%) $0.32
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$117.47 (-0.61%) $0.72
eBay Inc. Stock Quote
eBay Inc.
EBAY
$47.28 (-1.23%) $0.59
Cisco Systems, Inc. Stock Quote
Cisco Systems, Inc.
CSCO
$45.01 (-0.81%) $0.37
Western Digital Corporation Stock Quote
Western Digital Corporation
WDC
$47.09 (-5.65%) $-2.82
Dell Technologies Inc. Stock Quote
Dell Technologies Inc.
DELL.DL
Oracle Corporation Stock Quote
Oracle Corporation
ORCL
$77.35 (-0.07%) $0.05

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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