What the Best Companies Are Doing Right Now

Many investors are acting as if the end is near. But companies that aim to survive and thrive in the coming recovery aren't wasting any time on apocalyptic hype.

The credit crunch put the kibosh on the stock market's dependence on cheap and easy leverage. Plenty of businesses that relied on free access to capital, including Morgan Stanley and General Electric (NYSE:GE), have had to face an impossible dilemma: either lure new investors with terms that punish existing shareholders through dilution, or risk utter collapse if timely financing proves unavailable.

Companies with foresight, however, prepared themselves for this situation by raising and holding large amounts of cash. These businesses now find themselves in the driver's seat, having choices that most of their rivals can only dream about.

But now that cash has become valuable again, innovative companies aren't just sitting on their money. They're putting it to work -- and building future shareholder value for years to come.

The urge to merge
After a long lull over the past year, corporate acquisitions have started to pick up. There are plenty of good reasons for this:

• In an environment where competition is fierce, the advantages of consolidating companies with similar operations into a single big unit are extremely compelling.
• Valuations have fallen to nearly ridiculous levels, making the opportunity to grab up great businesses irresistible to cash-rich acquirers.
• With massive amounts of economic stimulus and other federal money coursing through the financial system, companies with cash have to realize that at some point, the lending logjam will break. To get the best deals, cash kings can't afford to wait.

That's why you've started to see some big deal proposals, including these:

Source: Yahoo! Finance.

In addition, other companies are making strategic investments short of full mergers, such as Aluminum Corp. of China's (NYSE:ACH) proposed $19.5 billion investment in Rio Tinto.

Still, even with stock prices as low as they have been lately, making an acquisition doesn't automatically guarantee success. How can you tell if a potential match makes sense for you as a shareholder?

Evaluating the new couple
The most important thing to remember about looking more closely at mergers and acquisitions is that every deal is different. What may make sense for companies in one industry may be crazy for other types of businesses.

Nevertheless, there are some general rules to look at in analyzing a new combination:

• Is the price right? Although you haven't seen many bidding wars for companies lately, the massive deluge of companies writing off goodwill from past acquisitions serves as a stark reminder that the deal-at-any-price philosophy can ruin what otherwise might be a smart strategy. Although shareholders of the target company obviously love pricey buyouts, the surviving company may not fare as well -- even if a cash-rich acquirer managed to avoid taking on debt to complete a deal.
• Look at culture. Often, competitors exist for a good reason: Different companies take a variety of paths in working within the same industry. Employees and managers alike rely on a certain corporate culture to get their jobs done, and the upheaval involved in changing long-held beliefs to accommodate a combined business entity can tear a company apart, hurting morale and encouraging key employees to depart.
• Remember context. A merger won't automatically fix problems that a pair of businesses has. Cost savings, increased efficiency and productivity, and the higher profile of being a big player in an industry can help the combined entity succeed. But if the industry itself isn't viable -- or if problems exist within a business that won't disappear just from an acquisition -- then the combination will prove unfruitful.

It's a good sign that many large companies are putting their cash to work. But don't simply take the company's word that a merger is a good long-term move. Do your own analysis, and if you think a company is making a mistake, don't wait -- take the money and run, and avoid the losses that will follow if you're right.

For more on finding the best companies in this market, read about:

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• Is the dollar doomed to fall?
• Even Warren Buffett got it wrong.