Excess Cash?

First (but quickly) today was a great day for my portfolio as GVHR, HSII and KFY all spiked up sharply. HSII had terrific earnings despite recessionary fears. They also gave a positive view on 2008. But something in their release made me think about MFI. Let me see if I can find it...

    Net cash provided by operating activities was $81.5 million, compared
to $60.4 million in the fourth quarter of 2006. Cash and cash equivalents
and short-term investments at December 31, 2007, were $282.9 million,
compared to $220.8 million at December 31, 2006 and to $218.2 million at
September 30, 2007. In early 2008, the company expects to pay approximately
$150 million related to 2007 bonus accruals.

Now the point is cash and the "formula". As readers may know, I get pretty close to matching the MFI website with a little spreadsheet I have built. For HSII I get very close to the website. But in that formula (in which I match the website), I use all cash as a reduction of market cap to determine enterprise value. The lower the enterprise value, the higher the earnings yield.

But think about the paragraph I pulled out from the release. HSII has a bunch of cash (I commented on that in an earlier blog), BUT they are going to pay $150m very shortly in bonuses. Now think about the formula and the company. The day before they pay those bonuses and the day after they pay those bonuses, there is really no difference in the company. They had accrued for those bonuses, so it does not hit their income. However, the Earnings Yield will suddenly be quite a bit lower (if they produced daily financial statements) as the EV will be higher.

This strikes me as wrong. The right way (in my opinion) is to split cash between excess and working. The excess would reduce EV, the working would increase working capital. I have played with that, but can't match the percentages in the website. That begs the question whether JG and the site match exactly what he used in his test or whether he has held something back? He does say in the book that the website attempts to emulate the returns from the study as closely as possible. So perhaps the website is "right", but it still seems wrong to me that cash about to be paid out should count to reduce EV.

It does make a major difference for some stocks. Take SIMG for example. Per the website they are 18% yield and >100% ROC.

Here is my calc matching the website:

		simg
+	Operating Income After Depreciation	28.18
-	Minority Interest - Income Account	-
=	Income for Calculation	28.18
	Market Cap Yahoo	401,720
	Share Price	4.77
+	Market Cap Calc	401.72
+	Preferred Capital	-
+	Short-Term Borrowings	-
+	Long-Term Debt	-
-	Cash and Short-Term Investments	249.71
=	Enterprise Value	152.01
+	Property Plant and Equipment - Net	24.19
+	Receivables	21.25
+	Inventories	20.20
+	Other Current Assests	17.72
-	Accounts Payable	17.89
-	Current Liabilities - Other	67.30
=	Invested Capital	24.19
	Earnings Yield	19%
	ROIC	116%

But if you split the cash by setting some aside for the current liabilities they drop to a very normal 13% and 45%. I dunno, seems a little more real to me. What do others think? Not all stocks drop that much, just those with a lot of cash and some current liabilities.

		simg
+	Operating Income After Depreciation	28.18
-	Minority Interest - Income Account	-
=	Income for Calculation	28.18
	Market Cap Yahoo	399,190
	Share Price	4.74
+	Market Cap Calc	399.19
+	Preferred Capital	-
+	Short-Term Borrowings	-
+	Long-Term Debt	-
	Cash and Short-Term Investments	249.71
-	Excess Cash	185.77
=	Enterprise Value	213.42
+	Property Plant and Equipment - Net	24.19
+	Receivables	21.25
+	Inventories	20.20
+	Other Current Assests	17.72
+	Working Cash	63.94
-	Accounts Payable	17.89
-	Current Liabilities - Other	67.30
=	Invested Capital	62.11
	Earnings Yield	13%
	ROIC	45%