7 Stocks Swimming in Cash

Some say cash is king. These days, many (The Economist, for example) are saying it loudly.

According to The Wall Street Journal, 64,000 companies bit the dust and filed for bankruptcy in 2008. In 2009, that number surged 38%, to just fewer than 90,000. Terrifyingly, there are still more to come.

For those companies that survived the first wave of the past two years, the really bad news is that debt will still require repayment, employees will still want their paychecks, and electricity bills will still fall on their doorstep every month. Federal stimulus will end, but companies will still need cash -- and the ones holding a lot of greenbacks should do quite well.

I've found seven companies that have tons of cash -- but that doesn't really matter. Let me explain why.

Cash helps, no doubt
I think we can all agree that adequate cash on the balance sheet is an excellent defense for a company facing complete, financial destruction. Without cash on hand, not even the most iconic of companies could survive. Bear Stearns, for example, went under not because of insolvency, but because it had no liquidity.

But there's a bigger problem.

You may be looking at the cash line on a company's balance sheet, with the belief that companies with lots of cash can avoid bankruptcy, and therefore be properly positioned to succeed in the future. You might be tempted to buy shares of these companies.

Not so fast.

I agree -- to some extent. These companies probably won't go bankrupt (in the near term, at least). But a company's amount of cash has nothing to do with how well it can or will do in the future. That train of thought will steer investors into a classic mistake.

Show me the money!
I've selected seven companies with market caps larger than $500 million and cash in excess of 12% of that market cap (which is a lot of cash!) to illustrate a simple point:

Source: Capital IQ, a division of Standard & Poor's.

These are relatively some of the "richest" companies in the world. But that fact alone doesn't have any bearing on whether they make for good investments.

These companies could be burning through cash faster than a teenager with your gold card -- or they could be tossing lots of money into that expensive new pet project that may or may not work.

You just don't know with these figures alone. The financial picture is entirely incomplete.

A tale of opposite extremes
DR Horton is a good example of a potentially misleading situation. Though the company has a significant amount of cash in its war chest, it also carries a debt load of nearly $3 billion, which must be serviced on a regular basis. In other words, DR Horton has to be pretty much operationally perfect, in a terrible housing environment, to avoid serious issues with its creditors. Ford, with its ridiculous $130 billion debt balance, is much the same way, even in spite of its large cash position. This type of situation would make me nervous as a shareholder.

General Electric, with its massive cash load of $70 billion, looks like it can completely command its own destiny -- until you realize that it has more than $516 billion of debt. Though it operates on a much smaller scale, Siemens is similarly encumbered, with debt obligations in excess of $24 billion. Pfizer carries nearly $49 billion of its own debt. All are strong names with good products, but I'd be generally reluctant to buy into them, especially now.

By contrast, both Dell and SanDisk maintain high levels of cash, offset by very reasonable levels of debt. In an environment like ours, this is a critical operational advantage.

There is a lot more to know about a potential investment, but from a capitalization perspective alone, these are seven companies in seven very different places.

Just one piece of the puzzle
Instead of merely highlighting companies with huge bank vaults, ask yourself whether a given company will be adding to that stockpile in the future, or taking away from it. And most importantly, identify just what the company intends to do with that cash.

Companies sporting well-filled coffers can't guarantee that their products will sell in the future, or that their industries are sustainable for the long term.

Businesses need cash to avoid bankruptcy in the short term, and to operate properly in the medium term. In fact, we Fools like our stocks to support healthy cash cushions in the (likely) event of an emergency. But cash can only get you so far. Companies still need to have a good plan for that cash.

The truth is stranger than fiction
There's another thing you should know about cash and the people who hold it. According to many different studies, the best managers of cash tend to be, ironically, the same companies that regularly redistribute it back to shareholders in the form of dividends.

As the master of your own money, you can probably appreciate how a dividend-paying company with limited resources must be more disciplined with its spending, because it knows it'll have to pony up a dividend to shareholders on a regular basis. Over the long run, these institutions generally become better stewards of capital.

The difference isn't marginal, either. Research has shown that from 1972 to 2006, S&P 500 dividend-paying stocks actually performed significantly better than their non-paying peers -- by a sizable margin of 6 percentage points per year! That outperformance can be at least partly explained by the burden (a blessing for shareholders) of having to pay a dividend regularly.

The Foolish bottom line
Cash is a good thing. Most companies can sidestep total collapse with lots of the green stuff. But having cash today won't help you navigate the difficult waters of business tomorrow. And it doesn't mean that you, as a shareholder, will ever see a dime of it.

That is why The Motley Fool's Income Investor service looks not only for companies with strong balance sheets -- so they can avoid bankruptcy in the present -- but also demands that its companies develop the long-term fiscal discipline that is promoted by paying a regular dividend. The strategy works: 76% of our recommendations are beating the market.

Want to take a free look? Click here for a 30-day trial to the market-beating service.

This story originally ran Feb. 1, 2009. It has been updated.

Nick Kapur owns no shares of any company mentioned above. Pfizer and Dell are Motley Fool Inside Value recommendations. Ford is a Stock Advisor recommendation. The Motley Fool has a disclosure policy.