Before investing in a company, we could consider analyzing its incomes, or better, its retained earnings, which show all the past returns available for being paid as dividends to investors/shareholders.
This may be the case of a company that pays dividends dependingon its profitability.
... but a company can have modest amounts of retained earnings and interesting amounts of cash - with all the associated liquidity risks.
This can go along with the immediate possibility to distribute dividends, as well as investing money and increasing the company’s market value.
Research of prof. Mikhail Simutin, University of Toronto, shows how there’s a positive relationship between corporate excess cash holdings and future stock returns.
’’The empirical evidence (...) suggests that firms build cash reserves in anticipation
of future investment’’.
He also found that ’’future investment activity is strongly and positively related to excess cash, with differences in investment persisting for up to ten years, but (...) no significant relationship between excess cash and future profitability’’.
That’s the point of separating cash analysis from the profitability analysis
In this research excess cash is referred to ’’holdings above what one would expect for companies in a similar line of business and with similar characteristics’’.
link of research: rotman.utoronto.ca
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