Some say cash is king.
These days, many 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. And, terrifyingly still, there are plenty more to come.
For those companies that survived the last three 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 eventually, but still companies 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 it doesn't really matter. Let me explain why.
Cash helps, no doubt
I think we can all agree that an adequate amount of 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 reading about all the cash that companies are holding these days and looking at the cash line on a specific company's balance sheet with the belief that this company can use that cash to avoid bankruptcy and other short-term liquidity problems. You might therefore come to believe that this company is properly positioned to succeed in the future. You might even be tempted to buy shares of this company.
Not so fast.
These types of companies probably won't go bankrupt (in the near term, at least), but it has nothing to do with how well the company 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 15% of that market cap (which is a lot of cash!) to illustrate a simple point:
Cash and Cash Equivalents
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
Dell is a perfect example of a potentially misleading situation. Though the company has a very significant amount of cash in its war chest, it also is in a perennially declining business: PC sales. The company's laptops are getting crushed by iPad sales and the future of desktops is seriously in doubt. Without a legitimate smartphone product in its lineup, I'd be seriously worried about the future of this company if I held shares.
Then there are situations like Ford, Transocean, and Valero. Each of these companies has plenty of cash, indeed. But they are all also shouldering very significant debt loads. Respectively, the total debt piles at each of these companies looks like $117 billion, $13 billion, and $8 billion. All of sudden, those huge cash piles now look a lot less impressive.
Then you have the Amgens, China Mobiles, and Strykers of the world. These companies all have the type of balance sheet that makes investors drool. But you still don't know a heck of a lot about the companies themselves. Are they growing? Are their products well-received? Are they able to effectively reinvest in their own businesses? Who knows?
There is a whole lot more to know about a potential investment.
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 generous coffers can't guarantee that their products are going to sell in the future or that their industries are sustainable for the long term.
Cash is necessary -- necessary 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 plan -- a good plan -- for that cash.
The truth is stranger than fiction
There is another thing you should know about cash and the people who hold it. The best managers of cash tend to be, according to many different studies, 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.
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 Million Dollar Portfolio service looks not only for companies with strong balance sheets -- so they can avoid bankruptcy in the present -- but also pursues investments that reward shareholders with dividends, stock repurchases, and other capital-enhancing activities. The strategy works, too: The service is beating the market by over 5%.
MDP is open to new customers for the first time in a year. Want to take a free look at this market-beating service? Enter your email address below to be a part of the service that is helping investors identify the most effective companies in the marketplace.
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