Beware of Cash-Rich Companies

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You're not going to like what I have to say today.

Over the years, you've been taught that companies stockpiling cash are winners. The fatter the legal tender pinata, the better, you've been schooled. "Cash is king" is a popular mantra around Fooldom, referring to both healthy balance sheets and companies that can generate gobs of cash flow.

As reasonable investors, we're trained to spot companies that have top-heavy income statements. However, before we get any deeper into earnings season, I have to warn you that cash-rich companies may break your heart.

The heavy burden of sandbags
As the interest rates that companies are collecting on their idle greenery continue to shrivel, the hurdle to top last year's performances are getting that much harder.

Let's start with Google (Nasdaq: GOOG).

	Q4 2007	Q4 2008	Change
Cash & Marketable Securities	$14.2 billion	$15.8 billion	11%
Net Interest Income & Other	$167.3 million	$69.9 million	(58%)

Source: Google.

See that? Even though Google closed out 2008 with $1.6 billion more greenbacks, its interest income took a dive. Instead of earning a yield of roughly 1.2% of its greenery balance in interest as it did during the final quarter of 2007 (or an annualized clip of nearly 5%), Google's idle balances netted a yield of roughly 0.4%.

Did Google grow its bottom line? Absolutely. It even trounced Wall Street expectations. However, it was the result of Google itself having to work even harder to grow its operating income to overcome the shortfall in generating interest income.

The same thing happened to Apple (Nasdaq: AAPL). It was another blowout quarter for the company, but it took a sharp hit in interest income during the period. The company may have closed out the period with a whopping $25.6 billion in cash, equivalents, and marketable securities, but the weighted-average interest rate on those funds clocked in at an annualized clip of 2.37%. A year ago, Apple was averaging 4.94% on its idle funds.

Nowhere to hide
Some companies are great at managing their greenbacks. Microsoft (Nasdaq: MSFT) only took a small hit in dividend and interest income during last week's otherwise lackluster report. In pursuit of chunkier yields, roughly a third of its nearly $21 billion in balance sheet green is invested in foreign government bonds and mortgage-backed securities. What will happen as more of its investments mature and Microsoft has to settle for lower yields or take bigger risks?

Intel (Nasdaq: INTC) saw its "net interest and other income" line item take a 91% hit. Sure, the "other" stipulation means that there are several other factors weighing in on that line beside the shriveling up of interest income, but anyone who doesn't see that cash-rich companies are going to be hard-pressed to inflate profits by leaning on their cash balances needs to start checking in on the pittance that money market funds are paying these days.

The upside to these blue chips is that even with billions -- and tens of billions -- in their coffers, interest income will only move the earnings per share needle by a few token pennies. The more pronounced impact will come on smaller companies that have yet to report.

Chinese travel portal eLong (Nasdaq: LONG), real estate broker ZipRealty (Nasdaq: ZIPR), and residential realty lead generator Market Leader (Nasdaq: LEDR) are trading within spitting distance of the value of their cash, equivalents, and marketable securities.

That is typically a dinner bell to deep value investors, save for the unfortunate point that all three companies are expected to post losses for their most recent quarters. Interest income has usually been there to soften the blow, but how will they fare now that the mattress has been deflated?

Cash is still king, but the moat is thinning
Don't get me wrong. It's a blessing to be armed with an arsenal of cash. It is the cash-rich companies that will make the most of this situation by gobbling up the competition, given the one-two punch of tightening credit markets and the unattractiveness of equity as a transactional currency.

However, slumping interest rates do tend to close the gap between the cash and the cash-nots. Leveraged companies that are able to lasso financing may do so at attractive rates, at a time when the cash-blessed companies struggle to squeeze more yield out of their idle funds.

This is not a call to dump your cash-rich companies. I may be dumb, but I'm not stupid. However, investors will need to factor in the impact that piddly yield will have on income statements over the next few quarters. In a market where missing or beating Wall Street expectations by pocket change can move stocks, year-over-year comps are going to be challenging for the rich stocks you love.

The world according to Microsoft:

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