The First Cut: Cash-Rich Firms
by John Bajkowski
The First Cut is designed as a starting point for investors. Each issue we list the top 30 stocks that pass relatively simple screens of interest to individual stock pickers. AAIIs Stock Investor Pro screening software is used to generate the First Cut listing.
With the credit market markets squeezed, cash is once again king. A firm has a better chance of weathering an economic storm while funding research and development, buying back shares, enticing buy-out offers, or even acquiring other companies with a large cash position. But excess cash has it disadvantages. For instance, it reduces profit margins when it earns a lower rate of return than other assets in the firm.
This issues First Cut focuses on firms trading with a high level of net cash per share relative to their share price. Net cash is a traditional measure of excess cash and is calculated by totaling cash, marketable securities and short-term investments and subtracting current liabilities. Beyond high net cash levels, firms making the First Cut have positive earnings and operating cash flow, as well as debt levels below the norm for their industry. Financial and utility stocks were excluded because of the unique nature of these sectors and special cash holding requirements. The 30 stocks with the highest level of net cash as a percent of share price made the First Cut. The listing also includes the earnings growth rate to examine recent growth, the market capitalization (share price multiplied by number of shares outstanding) to indicate the firm size, and the 13- and 52-week price changes to highlight short-term and long-term stock market performance.
A high net cash level relative to share price does not ensure financial strength or price stability. It is important to carefully examine the complete balance sheet, understand the growth potential and risk of the company and its industry, and trust managements ability to use any cash hoard wisely. A critical question to ask when looking at cash rich firms is: Why are they holding on to the cash?