Which Is Better: Cash or Stocks?

After making its most recent selection, the Inflation-Protected Income Growth Portfolio still has 15% sitting in cash -- 20% if you include the money allocated for the stock that still might get away. That's a significant amount of its cash sitting on the sidelines, waiting to be invested.

With interest rates so low, that idle cash is earning almost nothing -- a potential danger for a portfolio focused on investing for a rising income stream. Yet holding cash may be a better alternative than throwing money at stocks that don't meet the portfolio's standards. With the market up sharply early this year, it's getting tougher to find companies that fit.

Which raises a key question -- what to do with the cash:

  • Hold the cash and wait for the market to serve up more decent values?
  • Soften the portfolio's diversification criteria and accept more companies similar to ones already held?
  • Soften the portfolio's valuation criteria and accept lower expected rates of return?

The downside of a rising market
The company behind any given stock is worth the net present value of its expected future cash flows. That's a fancy way of saying that what a company does in the future determines what it's worth today. In most cases, those future prospects do not depend at all on where the stock is trading in the market.

If you hold that future constant, the lower a stock's price is today, the higher your expected future returns from buying the stock. The opposite holds true, as well; the higher a stock's price today, the lower your expected future returns. As a result, the fairly strong opening weeks of 2013 have lowered the expected future returns of owning many otherwise worthwhile stocks.

Take Emerson Electric  (NYSE: EMR  ) . When the iPIG portfolio first launched last December, the company had a market capitalization of around $36.0 billion. A discounted cash flow analysis conducted at the same time pegged its intrinsic value around $39.3 billion. The company traded at a small discount to what looked like fair value.

This past Friday, however, Emerson Electric closed with a market price of $41.5 billion -- slightly ahead of that fair value estimate. Had the market price not risen so substantially -- nearly 15% -- in such a short amount of time to rise past that value estimate, it would be in consideration for potential purchase by the portfolio today. With over 50 years of a rising dividend and a healthy balance sheet, it would be a strong contender for a slot in the iPIG portfolio.

Is diversification helping or hurting?
Another criteria a stock has to pass in order to make it into the iPIG portfolio is that it has to fit from a diversification perspective. That rule has already been loosened once for the portfolio in an acknowledgement that the vast majority of the benefits of diversification can be met with relatively few stocks.

If the diversification criteria were to be loosened again, Intel (NASDAQ: INTC  ) would seem to be a decent fit, as well. As of Friday's close, that microprocessor titan is still trading below the $117.6 billion estimated for its fair value. With its healthy balance sheet and its near-decade-long streak of raising its dividend, it would seem to be a worthy candidate -- especially with its reasonable stock price tag.

The only problem is that the portfolio already includes Microsoft (NASDAQ: MSFT  ) and Texas Instruments (NASDAQ: TXN  ) . Microsoft represents the other half of the "wintel" personal computing powerhouse, and Microsoft's and Intel's fortunes have for a long time been incredibly closely linked. Texas Instruments, like Intel, is a semiconductor titan, and the two are thus exposed to many of the same industry-shaking events.

Loosening the diversification rules to allow the iPIG portfolio to own Intel as well as Microsoft and Texas Instruments would likely put around 15% of the portfolio's cash to work in that high-tech industry. You might try to make the case that it's so unlikely that those titans would succumb to any trip-ups that the risk would be negligible, but that would ignore the harsh lessons from the recent financial meltdown.

Citigroup (NYSE: C  ) was once America's largest bank. It still is a behemoth, with nearly $2 trillion in assets. Yet it, along with many other major banks, was forced to slash its dividend to $0.01 a quarter as those financial issues unfolded. It even underwent a 1-for-10 reverse split to keep its stock out of penny-stock territory (and then cut that dividend again to maintain the abysmal $0.01-per-quarter level). That meltdown hit many other banks, too -- a nearly industrywide collapse.

What's to keep a disruption from radically changing the high-tech industry and forcing the tech triumvirate of Microsoft, Intel, and Texas Instruments to slash their dividends as well? The industry is incredibly well known for disruptive innovations, so in some sense, the chances might be at least as good as the "black swan" of the mortgage meltdown that took down so many banks.

So what would you do? Let us know in the poll below.

Read more about Intel
When it comes to dominating markets, it doesn't get much better than Intel's position in the PC microprocessor arena. However, that market is maturing, and Intel finds itself in a precarious situation longer term if it doesn't find new avenues for growth. In this premium research report on Intel, our analyst runs through all of the key topics investors should understand about the chip giant. Better yet, you'll continue to receive updates for an entire year. Click here now to learn more.


Read/Post Comments (2) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 11, 2013, at 2:25 PM, WETNTITEN wrote:

    Citigroup is a $60.00 stock comes August 2013 this summer, my Canadian friends are buying by the thousands shares here....good luck.....believe me, it's time to buy now....!

  • Report this Comment On February 18, 2013, at 9:01 PM, NewAlchemist wrote:

    If the economy takes a turn for the worst Citi will get hit hard. This time the American public really doesn't have the appetite for another round of bailouts.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2248242, ~/Articles/ArticleHandler.aspx, 10/23/2014 2:56:28 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Apple's next smart device (warning, it may shock you

Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early-in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!


Advertisement