Have you ever seen that line item on the balance sheet listed as marketable securities and wondered what they were?
I know I did when I first started reading a company’s financials.
Well, you are in luck because today, we will dive into each line item and open up your eyes to this fascinating topic; well, maybe not exactly fascinating, but important to understand.
Most investors with little knowledge regarding marketable securities on the balance sheet associate them with “boring” companies like the insurance industries, but did you know Microsoft’s largest asset on their balance sheet is marketable securities? It’s true; you can look it up.
Companies like Apple, Amazon, and Google invest much of their cash in marketable securities while waiting for other opportunities to deploy that cash.
In today’s post, we will learn:
- What are Marketable Securities?
- Where are Marketable Securities on the Balance Sheet?
- How Are Marketable Securities Valued on the Balance Sheet?
- Impact of Marketable Securities
- Investor Takeaway
Okay, let’s dive in and learn more about marketable securities and their impact on companies.
What are Marketable Securities?
Marketable securities, according to Investopedia:
“Marketable securities are liquid financial instruments that can be quickly converted into reasonably priced cash. The liquidity of marketable securities comes from the fact that the maturities tend to be less than one year, and that the rates at which they can be bought or sold have little effect on prices.”
Marketable securities on the balance sheet are a mixture of investments ranging from commercial paper, bonds, and money market accounts to stocks.
We have different levels of marketable securities; more on that in a moment. But, typically, marketable securities hold for a year or less, and companies use them as short-term investments.
Marketable securities aim to give companies a safe, secure place to park cash and make a few bucks.
Some companies have different goals with their marketable securities, and there are multiple accounting definitions to help investors understand those goals.
Most companies hold marketable securities in debt securities that mature within one year but can also hold stocks, depending on the company.
For example, Warren Buffett and Berkshire Hathaway hold most of their investments in equities or stocks and a smaller portion in short-term debt such as T-bills or bonds. Markel (MKL) also plays in this camp, the re-insurance company run by Tom Gayner.
But others, such as the large insurance giants such as Prudential (PRU), Principal (PFG), and Allstate (ALL), hold much of their marketable securities in debt securities such as bonds of many different flavors.
Why Do Companies Hold Marketable Securities?
The next question is, why do these companies hold these in marketable securities?
Most companies hold excess cash as a reserve if needed quickly, such as a possible acquisition or making debt payments if cash flow dries up.
Instead of holding all cash in a savings account earning diddly, the companies elect to invest in marketable securities as short-term liquid investments. Instead of the money sitting there and not earning anything, the company can earn returns on its cash.
As the need for quick cash arises, the company can liquidate its short-term securities to fund that need.
All marketable securities are financial instruments bought and sold on public markets, bond exchanges, or stock exchanges. This means they are accounted for as marketable equity or debt security.
Another requirement of marketable security has a strong secondary market, which allows for quick turnarounds of the marketable securities.
The returns are typically quite low as marketable securities are liquid and safe.
Examples of marketable securities are:
Marketable securities can be common stock or preferred stock. Companies hold public equities on the company’s balance sheet purchasing the equities, and the expectation of holding the stock is for less than one year.
If the company expects to hold those securities for longer than one year, then the marketable securities list as a non-current asset and all marketable securities are listed on the balance sheet at the lower value of cost or market; more on that in a bit.
Marketable debt securities such as T-bills or corporate bonds are short-term. And as with the equities, they must have a strong secondary market for resale, all debt securities held on the balance sheet list at cost, and are a current asset until realizing a gain or loss from the asset’s sale.
Commercial paper and money markets are securities corporations hold to provide highly liquid returns. Think of these as more exotic savings accounts at your local bank.
They earn better returns than savings accounts but are as liquid as savings accounts.
Okay, let’s find where companies hold marketable securities on the balance sheet and some defining of these securities types.
Where are Marketable Securities on the Balance Sheet?
In accounting, marketable securities are current assets and sometimes work capital calculations on corporate balance sheets.
Many companies will list if the marketable securities are a part of working capital calculations. For example, the description of adjusted working capital views only operating assets and liabilities. They exclude financing assets or liabilities, such as short-term debt and other marketable securities.
Next, let’s look at a balance sheet and try to understand how to locate and decipher what we see.
My first guinea pig is Microsoft (MSFT) from its latest 10-q or quarterly report from June 30, 2022.
For ease of use, I highlighted some line items to analyze.
First, the marketable securities are at the top of the balance sheet and are under the balance sheet’s current assets section.
Remember that current assets are the most liquid assets a company owns, and they list in order of liquidity. This tells us that cash is number one, but right below that are the marketable securities.
Other areas to notice are the number of current assets in relation to total assets and the construction of those assets. In Microsoft’s case, the marketable securities comprise roughly one-quarter of the company’s total assets.
Also, notice that the company does invest in equity securities, but those are on a line item below the current assets, meaning that Microsoft will hold the securities for longer than one year.
Let’s look at another company, Prudential (PRU), to get another flavor of how the balance sheet looks—taking information from the following balance sheet from Prudential’s latest 10-K dated December 31, 2022.
Okay, there is much more to unpack from the above balance sheet snapshot.
First, the company has far more investments than Microsoft, and as an insurance company, Prudential invests in various different-length assets to match the insurance premiums they collect.
An insurance company’s income stems from a direct relationship between the premiums they collect, the costs associated with those premiums, and the investment income that Prudential earns.
Therefore, Prudential uses its investments to drive more income than Microsoft. And because of that need, the company invests in a wide range of securities, primarily debt securities.
As we look at the above balance sheet, we see line items referring to:
Fixed maturities, available-for-sale
Fixed maturities, held-for-sale
Fixed maturities, trading
Equity securities, at fair value
We will cover those in the next section; I wanted to start to put some of these terms in our heads.
One item to remember when looking at the balance sheet and marketable securities. All the line items listed on the balance sheet always appear in order of liquidity. So if you remain unsure about how liquid a company is, remember that the line items occur in order of liquidity or the ability to convert to cash quickly.
Don’t get bogged down in all the jargon related to the more complicated financial companies such as insurance companies or banks. All companies look to maximize their cash, whether deploying it in assets that earn them a high return or in lower-yielding assets that remain safe but liquid.
Okay, next, let’s look at determining marketable securities’ value and defining some of the terms associated with those values.
How are Marketable Securities Valued on the Balance Sheet?
Short-term liquidities or marketable securities have many different classifications for accounting based on the purpose of their purchase.
There are three different classifications for marketable securities:
- Available for Sale – an available for sale (AFS) is a debt or equity purchased with the intent of selling it before it reaches maturity or holding for longer than one year if it has no maturity. AFS or available-for-sale securities report on the balance sheet at fair value. Here is an example of available-for-sale from Prudential’s balance sheet notes.
- Held-to-Maturity – these are securities purchased to be held until they mature, typically bonds or other debt securities. Because stocks do not have maturity dates, they are not held-to-maturity securities. Insurance companies maturities match the long or short-term nature of their premiums. For example, life insurance will hold longer maturity bonds, whereas a car insurer will hold short-term bonds to match the liability. Below is an example of held-to-maturity securities from Prudential’s note section.
- Held-for-trading securities –held-for-trading security is an asset purchased to sell in the short term. In many instances, less than a year. The hope is the company will see an increase in value and sell for a profit in the year.
The vast majority of marketable securities on the balance sheet are fair value.
So what does fair value mean?
Fair value means the security’s fair value relates to the value the security will trade for on the market. For example, if a T-bill is trading at $104, the company will list the T-bill at a fair value of $104.
So when we see the fair value on the balance sheet, the fair value equals what the security would be worth if the company sold it at the time of the financial statement.
You will see terms such as:
- Unrealized gains
- Unrealized losses
And those terms break down to tell us what the company would gain or lose on those investments if they sold the securities when creating the balance sheet. It is not the portfolio’s actual value; that is the fair value in total, not the gains possible if it sold the security.
Okay, now that we understand marketable securities and their value, let’s look next at their impact.
Impact of Marketable Securities
Most companies earn most of their income from their core business, as Microsoft earns most of its income from computer hardware, cloud services, and other assorted products.
But they also earn monies from their marketable securities or cash held until they find something better to do with the funds. In Microsoft’s case, in the last three years, Microsoft has earned:
Remember that those are big numbers, far from chump change, but pale compared to Microsoft’s income of $72,738 million. But any extra the company or company can earn is better than nothing.
In fact, Apple, which has approximately $104 billion in cash, has the bulk of that cash in marketable securities, with $90 billion of those in stocks, 86% of its cash position in marketable equities.
Any dividends or sales of those marketable equities contribute to those companies bottom lines.
As I mentioned earlier, this is one of the primary income methods for insurance companies.
Most marketable securities reside on the balance sheet, under the assets sections as current or long-term assets. But they also have a place in the shareholders’ equity section as an unrealized gain and list at their current market or fair value until they realize that gain.
But those gains or losses from the sales have to go somewhere and flow to the income statement. They list a gain or loss on trading securities on the income statement.
The income earned from the investments also lists interest or expense from the dividends or interest gained from the securities. For example, bonds pay a dividend quarterly, bi-annually, or yearly, depending on the bond. And that income flows to the company’s income statement owning that security.
In the case of Microsoft, that flows as interest income.
Prudential lists on the income statement as net investment income, such as below.
As we can see from the above example, the net investment income is a little over 27% of Prudential’s total revenue.
For further information regarding the net investment income, we look in the notes for Prudential under the investments note, and we find the breakdown by the security of the earnings.
Notice that the net investment income from the notes matches the income statement’s income.
The above illustrates the importance of marketable securities to businesses such as insurance companies, banks, and other financial companies.
But they are also a source of income for others, such as Microsoft and Apple, in different ways. Microsoft carries a much more conservative, liquid portfolio, as most of its investable assets are in short-term securities. Apple invests in equities for the long term and focuses less on the gains or losses from its portfolio.
Alright, let’s look see how this helps us as investors.
Investing in complex financial companies such as insurance companies requires understanding the business and the different jargon and layout of financial statements.
Insurance companies earn much of their income from the premiums it collects and a substantial portion from their investment portfolios.
After they collect those premiums, insurance companies use the money to earn additional income while waiting to pay out those premiums in the event of a claim. Most insurance companies try to match the duration of those investments to the risks associated with claims.
For example, life insurance policies, referred to as long-tail premiums, have a long life span, often 20 to 30 years. And it makes sense to match those policies with investments that can earn the company the most money, and in the case of liquid investments, those are long-term bonds.
Analyzing companies’ income statements and balance sheets is crucial in understanding any company, especially an insurance company.
There is a direct correlation between an insurance company’s assets and its income, as evidenced by the Prudential income statement and balance sheet.
The correlation is less noticeable in a company like Microsoft, Amazon, or Apple. But it is important to note all three companies do an amazing job creating excess free cash, which they need to earn a few extra bucks.
Unfortunately, these companies will not have amazing ideas to plug the cash into a space to create outstanding returns. In the meantime, while looking for those opportunities, earning extra income on the spare cash makes sense.
Understanding marketable securities’ impact on an insurance company or bank and “normal” companies like Microsoft can help you understand management’s decisions and capital deployment.
Warren Buffett understands, better than most, the importance of capital returns on investments and the need to find greater and greater investments to generate those returns.
Not every hit is going to be a home run.
Buffett understands this, so he is content to sit on his hoard of cash, waiting for better opportunities to find another investment to create a great return on investment or another company to buy to generate the return.
And with that, we will wrap up our discussion on marketable securities on the balance sheet.
As always, thank you for taking the time to read this post, and I hope you find something of value on your investing journey.
If I can further assist, please don’t hesitate to reach out.
Until next time, take care and be safe out there,